The Economic Tsunami

U.S. economic fears shift from Europe toward ‘fiscal cliff’

By Michael A. Fletcher and Zachary A. Goldfarb, Published: July 17

The main threat to the economy is shifting from what others may do to us to what we are doing to ourselves.
For much of the year, economists worried about the impact of the slowdown in Europe on the U.S. economy. Now, analysts say anxiety about the impact of the fast-approaching fiscal cliff — the series of federal spending cuts and tax hikes set to take effect at the beginning of 2013 if Congress and the Obama administration do not act — is displacing Europe as the primary threat to the nation’s sputtering economy.
Morgan Stanley said this week that concerns about the fiscal cliff are reaching new heights across a wide range of industries. It is already seeing reductions in business orders and hiring, among other areas.
“While our analysts are somewhat less worried about the impact of European bank strains,” a Morgan Stanley report said Monday, “the negative impact of fiscal cliff uncertainty is becoming more widespread.”
The potential economic impact could smother the flickering recovery and further stifle job creation, analysts warn.
A new report commissioned by the aerospace industry says federal budget cuts set to take effect in January could cost the country’s economy more than 2 million jobs and raise the national unemployment rate by 1.5 percentage points over the next year.
“The results are bleak but clear-cut,” said Stephen S. Fuller, the George Mason University professor who wrote the report. “The unemployment rate will climb above 9 percent, pushing the economy toward recession and reducing projected growth in 2013 by two-thirds.”
The report echoes warnings from economists and policymakers who are urging lawmakers to find a way to put the nation on a sustainable fiscal path without derailing short-term growth.
“Do no harm,” Federal Reserve Chairman Ben S. Bernanke told lawmakers Tuesday, repeating a warning to policymakers to take action to avoid the sharp spending cuts and tax hikes.
Bernanke’s comments at a Senate hearing followed decisions by other top economic forecasters this week to reduce their expectations for U.S. economic growth, in large part because of the uncertainty about the fiscal cliff.
Economists say the automatic actions slated to take place at the end of the year — an increase in payroll taxes and in income tax rates, as well as large cuts in domestic and defense spending — would tip the country back into recession.
Congress could prevent that outcome, but lawmakers are pledging to do so only on their terms, creating fears of more partisan gridlock. Democrats insist that taxes rise for higher-income earners; Republicans want to include the affluent in any renewal of the George W. Bush-era tax cuts.
Meanwhile, the prospect of a government-induced recession is already taking a toll on the economy.
“The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery,” Bernanke said in testimony to the Senate banking committee. “Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.”
He said the economic recovery has lost momentum in recent months, sapping consumer confidence and crimping job creation.
But Bernanke gave no indication as to whether the Fed would take additional steps to try to boost growth at its meeting later this month. He said the central bank’s decision on any further fiscal stimulus would turn on whether it determines that the job market is recovering or is “stuck in the mud.”
Bernanke added that concerns about the fiscal cliff, along with ongoing economic problems in Europe, are a significant drag on U.S. growth. He noted that the Congressional Budget Office has estimated that going over the cliff would trigger a shallow recession early next year.
“These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved,” he said.
After strong gains at the end of 2011 and in the first three months of this year, job creation has slowed substantially. The nation’s unemployment rate is 8.2 percent, marking 41 consecutive months that it has hovered above 8 percent.
The manufacturing sector in June contracted for the first time in three years, according to private data released this month. Also, U.S. retail sales fell in June for the third consecutive month as consumers cut spending.
Bill Gross, founder of the investment management firm Pimco, said on Twitter that the nation is “approaching recession when measured by employment, retail sales, investment, and corporate profits.”