Summer Slowdown: Why the Economic Recovery May Be Stalling

July 1, 2010 — -- The rest of the summer won't necessarily be cruel, but it will at the very least be slow, according to some leading economists. The big gains seen in important measures of economic health like gross domestic product just a few months ago are being replaced by more modest increases, they say.

"I don't expect robust growth," said Douglas Holtz-Eakin, the former director of the Congressional Budget Office who was John McCain's top economics advisor during the 2008 presidential campaign. "This is a slow, steady crawl-out."

Wider acceptance of such a forecast helps explain the drop in the stock markets in recent days, he said.

"They've come to grips with this," he said. "They were overly optimistic before and now they've marked themselves to the reality."

What's prompting the deceleration of the recovery? Here's a breakdown, according to experts:

Inventory: During the worst of the financial crisis, as sales plummeted, businesses cleared their shelves instead of restocking.

"The inventory destocking was making a huge negative contribution to the GDP," said Alan S. Blinder, an economics professor at Princeton University and a former vice chairman of the Federal Reserve.

By late last year, Blinder said, businesses reversed course and began building up their inventories again, leading to a dramatic boost in economic activity. The impact, however, was only temporary and is no longer a major driver in the recovery, he said.

"You can't expect inventory stocking to keep building and building," he said.

Housing: The federal tax credit for home buyers helped bolster the long-ailing housing market, but now that it's ending -- the government extended the deadline for the credit Wednesday, but only for buyers who have already signed purchase agreements -- housing sales are hitting the doldrums once again. A report released today by the National Association of Realtors said that purchase contracts signed in May dropped to a record low.

Critics say that the home buyer credit, instead of providing a sustained benefit to economic growth, just encouraged would-be buyers to make their purchases sooner rather than later.

"You pulled forward (home sale) activity," said Citigroup U.S. economist Steven Wieting. "Consequently, now there's a larger decline in sales."

Why Economic Recovery May Be Slowing

Stimulus: Economists continue to debate exactly how much last year's $787 billion stimulus package contributed to the country's economic recovery. And some who believe the stimulus did indeed have a significant effect acknowledge that its effects are now wearing off.

Blinder said that it's still better than not having had a stimulus package at all.

"A lot of us believe, based on models, experience, etc., that the downswing would have much more severe and long-lasting if not for the fiscal stimulus," he said.

Deficit: As the U.S. government borrows more money -- the deficit is headed toward $1.5 trillion this year -- investors are finding more opportunities to buy government debt.

That's bad news for U.S. businesses, said Kent Smetters, a professor at the University of Pennsylvania's Wharton School and former deputy assistant secretary of economic policy at the U.S. Treasury.

"High deficits can really crowd out private investment," he said.

Smetters said if government debt wasn't an option, investors might be more inclined to put their money into business instead, which would promote private sector growth.

But not everyone agrees that growing deficits are bad, especially now. Nobel Prize-winning economist Paul Krugman, who worries that the U.S. is in the midst of a depression, warns that "premature austerity" and "inadequate spending" by a government intent on balancing budgets could hurt the economy.

"While long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating," Krugman wrote in his most recent column in The New York Times.

Unemployment and Unemployment Benefits: A report released by the Labor Department today provided some discouraging news on the jobs front: new claims for state unemployment benefits last week rose by 13,000.

Economists expect more bad news ahead: While the U.S. economy gained 431,000 jobs in May, but June's figures are unlikely to come anywhere close to that. Experts predict that on Friday, the U.S. Bureau of Labor and Statistics monthly employment report will show a loss of more than 100,000 jobs.

The decline, they say, is a result of the government cutting some of the hundreds of thousands of temporary Census jobs that largely fueled May's jobs gains.

Citigroup's Wieting said he expected to see job losses last at least another month, thanks to the elimination of Census positions.

"Once those cycle through, you'll get gains in private employment, in all likelihood," he said.

But those gains aren't expected to be great either.

Though corporate earnings have improved, businesses seeking to limit their vulnerability to new taxes and health insurance liabilities have "no incentive to hire back unless it's absolutely necessary," Wieting said.

In the meantime, many unemployed Americans are at risk of losing a vital source of income if Congress -- engulfed by concerns over the rising deficit -- fails to pass the another extension of unemployment insurance.

The Senate Wednesday night rejected a measure to restore and extend unemployment benefits for the long-term jobless. Democrats vowed to continue to try to get the measure passed.

The expiration of unemployment benefits will hurt consumer spending, Blinder said.

"You give money to the unemployed and they will spend it," he said.

But Holtz-Eakin argues that the impact of spending declines by the unemployed won't be great enough to affect economic recovery.

"If you do the math," he said, "the numbers aren't big enough in a $14 trillion economy."