Prospect of more battles over budget unnerves economists

The political shootout during this summer’s debt standoff ended up wounding the economy, and the threat of more missteps as Congress and the White House resume their budget battles next week looms as one of the biggest risks for an economy already perilously close to recession, economists warn.

Washington’s poor handling of the debt crisis caused the first-ever downgrade of the nation’s top credit rating and contributed to the worst turmoil in financial markets and biggest drop in consumer confidence since the 2008 financial crisis and recession. The developments continue to reverberate and cast a cloud over the economy.

While consumers and investors were shaken to the core, economists suspect businesses responded in kind, postponing plans for hiring and investment during the month and dimming the already weak outlook for growth and jobs. A report Friday is expected to show as few as 25,000 jobs created last month as employers — like others — stepped back and watched aghast at the unfolding train wreck in Washington.

With the recovery now hanging in the balance, even independent analysts who usually avoid commenting on politics are speaking out about the dangers of further gamesmanship and gridlock for the economy.

“The potential for more bitter and damaging political standoffs is high,” and the “massive uncertainty” clouds the future for the markets and economy, said Nariman Behravesh, chief economist at IHS Global Insight. He said the economy is barely “staggering forward” in the wake of these self-inflicted wounds.

“The single-biggest risk facing both the United States and Europe is a policy mistake” that would take away stimulus that is helping to hold up growth, he said, noting that the budget impasse is threatening to prevent the extension of payroll tax cuts and other stimulus measures enacted at the end of last year.

Those measures are adding about 1 percentage point to economic growth this year — no small contribution when growth is running at less than 1 percent, he said.

Federal Reserve Chairman Ben S. Bernanke also warned last week that political machinations that led to the downgrade last month hurt the economy.

“The negotiations that took place over the summer disrupted financial markets and probably the economy as well,” Mr. Bernanke said in a speech in Jackson Hole, Wyo. “The country would be well-served by a better process for making fiscal decisions.”

Many economists view Mr. Bernanke’s warning as understated, given the evidence of economic damage that is piling up by the day.

“The drama around the lifting of the U.S. debt ceiling has weighed down on financial markets and eroded business and consumer confidence,” said Joachim Fels, an economist at Morgan Stanley. Confidence in government in particular has collapsed to record lows, according to surveys.

“A negative feedback loop between weak growth and soggy asset markets now appears to be in the making” at a time when the economy is “dangerously close to recession,” Mr. Fels said. “This should be aggravated by the prospects of fiscal tightening” as the stimulus ends later this year and budget cuts take hold.

The precipitous fall in consumer confidence in the past month was widely attributed to the unsettling budget struggle and is particularly foreboding for the economy, since consumer spending normally fuels about 70 percent of economic activity and was already weak for much of the year.

Thursday’s preliminary reports on retail sales during August suggested that consumers did not pull back as much on spending as feared despite the massive loss of confidence, which was focused on the political system rather than personal finances.

The University of Michigan, which has been tracking consumer sentiment for decades, noted an unprecedented “sense of despair and pessimism about the role of government” in its survey for August, while the Conference Board also attributed a dramatic drop in its confidence measure to political factors and the stock market rather than the usual worries about jobs.

Like the public at large, economists say both major political parties deserve blame for not putting the public interest ahead of their own political goals and re-election prospects. Keeping the economy afloat while paring deficits is difficult, but it can be done when the parties cooperate, they note.

Edward B. Barbier, an author and economics professor at the University of Wyoming, said President Obama waited too long to endorse the recommendations of his deficit commission, which in December called for a $4 trillion plan of spending cuts and tax reforms to tame the debt over 10 years, combined with measures to bolster the economy in the short term.

By late spring when Mr. Obama embraced the proposal, Republicans had gained momentum with their agenda to immediately cut spending and it was too late for the president to avoid an all-out political war and lay the groundwork for pushing such a “grand bargain” through Congress. The delay also proved to be devastating for the nation’s credit rating and confidence on Wall Street.

Championing a bipartisan approach earlier “would have signaled to the markets and the rating agencies that tackling U.S. deficits and debt in the medium and long term, once economic recovery had started in earnest, would be the main priority,” Mr. Barbier said.

Instead, Standard & Poor’s Corp. last month cited Washington’s failure to pass such a grand plan as its reason for downgrading the U.S. to AA+ from AAA. The ratings agency said it could take years for Washington to prove it is serious about gaining control over the debt and reverse the damage to the nation’s credit status.

But Mr. Barbier also casts considerable blame on Republicans in Congress, whom he accused of bringing the economy “to the brink” with their ideological rigidity over taxes.

“Clearly, the Republican Party has been irresponsible in promoting this ideological political stance,” which “has focused purely on cutting spending and not managing either the recession or medium-term budget deficits,” he said.

“Stop playing politics with the U.S. and world economy. This is a message that the Republican leadership in Congress must especially heed,” he said.

Stan Greenberg of the Democracy Corps polling firm said voters overwhelmingly “downgraded” Washington last month in the wake of S&P’s historic downgrade of the nation’s credit rating, and for much the same reason — debilitating political gridlock.

“The debt ceiling debate was a kind of mutually assured destruction for the two parties,” with more than half of all voters saying they would consider a third-party candidate in the 2012 presidential election, he said.

While both Democrats and Republicans suffered, the ratings of Republicans in Congress and House Speaker John A. Boehner, Ohio Republican, fell the furthest and hit record lows as they were perceived as less attuned to voters’ needs, he said.

The loss of confidence in Washington on Wall Street and among the public at large is justified, “given the political gridlock and unwillingness to compromise,” said Nejat Seyhun, a finance professor at the University of Michigan Ross School of Business.

The president’s deficit commission showed how a bipartisan plan to pare the debt and aid the economy could be put together, he said, but “unfortunately we missed that opportunity.” It is not clear whether the supercommittee created last month to recommend another $1.5 trillion in deficit cuts will follow the same path, he said.