Mickey Levy: No Double Dip

Includes: DIA, QQQ, SPY
by: Harlan Levy

Bank of America Chief Economist, Mickey D. Levy analyzes and forecasts national and international economic performance and financial market behavior and conducts research on monetary and fiscal policies. Levy, a widely quoted economic observer, is also an adviser to several Federal Reserve Banks.

H.L.: What‘s your take on the U.S. economy in light of the mix of economic data showing 51 million Americans without health insurance; 44 million in poverty, 14.3 percent of the population; better job numbers; bad housing numbers; a surging stock market; and flourishing corporations?

M.L.: There’s good and bad news. The good news is recent data suggest that the economy is emerging from a soft patch and that economic growth will be moderate, and the economy will not endure a double-dip recession.

The bad news takes several forms. Firstly, the rate of economic growth likely will be moderate and below its historic trend. That means businesses will be hiring only modestly, and the unemployment rate will recede modestly but remain uncomfortably high, and the duration of unemployment for those who have lost jobs will remain very high.

Secondly, potential growth for the economy over the next handful of years has been reduced by the financial crisis and by government responses to the crisis, including the dramatic increase in government debt and debt service.

Thirdly, the U.S. economy and policy makers face daunting tasks: We need to get the economy back on a stronger long-run growth path with sustainable government finances, and there’s widespread disagreement on how to accomplish these tasks.

H.L.: What should be done?

M.L.: With regard to the government budget deficits, we need a long-term plan that will eventually cut deficits without doing so immediately. That will build creditability with the public and restore confidence that we’re getting back on track.

It’s widely acknowledged by experts on both sides of the political aisle that in order to achieve long-run fiscal responsibility the entitlement programs must be cut. What is needed is a meaningful compromise that combines spending cuts that require restructuring benefit schedules and tax increases that are implemented with a lag, so they do not affect near-term economic conditions. Restoring confidence is a key factor that would help the current economic environment and reduce some of the uncertainty that’s hanging over household and business decision-making.

State and local governments must also address their massive fiscal problems. I fully recognize the political obstacles to doing so, but unsustainably generous public-sector pensions must be adjusted for future generations of workers.

H.L.: What are some specific things to do?

M.L.: Extensions of unemployment compensation are humanitarian and necessary obviously in these difficult economic times. People need support, and the government should provide it. At the same time, policies need to address factors that have been inhibiting growth and business decisions to hire and put in place longer-run pro-growth policies.

I would like to see more government spending on infrastructure projects that actually add to our productivity and productive capacity. I’m not talking about political patronage jobs or other such wasteful projects. I would like to see a true efficient upgrade of our energy policy and energy grid. I would like to see more permanent government subsidies of research and development. I would like to see fewer disincentives for exporting companies.

My read is that some of the key programs of the fiscal stimulus package, although well-intentioned, were not well designed and did not create permanent jobs. Government needs to work closely with businesses – remember, they do the hiring – to identify sources of uncertainty that have inhibited hiring and expansion plans and take steps to reduce those uncertainties and create a more favorable environment.

We all know that many households need to save more and reduce their debt levels, and that will constrain the rate of growth of consumer spending. That makes the job of stimulating growth difficult. However, there are ways to improve the environment for long run growth, and there I encourage policy makers on both sides of the aisle to try to be less political and identify areas of policy agreement.

H.L.: What do you think of extending the Bush tax cuts with or without the tax cuts for those making over $250.000 a year?

M.L.: If policy-makers think taxes should be lower for lower and middle-income families, make those cuts permanent. Temporary changes don’t work well. Regarding higher taxes for higher-income people, make sure they are associated with future spending cuts as part of a meaningful move toward long-run financial responsibility, and make sure you protect small-business owners from the higher tax rates, because we do not want to deter them from hiring.

H.L.: Are the tax cuts for the wealthy very important to lots of small businesses and the overall economy, which Republicans in Congress claim and the Democrats deny?

M.L.: The answer is somewhere in between. Certainly not all small business owners would have their hiring decisions affected by a higher marginal tax rate, but there are probably enough that would be affected, such that at this stage of the economic cycle, with sky high unemployment, policy-makers need to be very cautious.

For example, some small business owners with more than $250,000 in income might be private entrepreneurs, and higher taxes would not affect their hiring decisions. One can argue that it would be appropriate for them to pay higher taxes. However, there are also numerous companies with, say, 100 employees, with the CEO’s earnings exceeding $250,000 that would be affected by higher taxes. At this stage of the recovery with sky-high unemployment, policy-makers must be careful not to throw up another roadblock to job creation.

H.L.: What do you make of the stock market’s rise, and will it continue?

R.W.: The recent rise in the stock market has reflected improving economic data. Over the summer, economic forecasts and market pundits became too pessimistic. Now, with economic news improving relative to those pessimistic expectations, stock prices have moved up.

The outlook is interesting: Corporations likely will continue to generate healthy profits, as they match modest increases in product demand with tight controls over operating expenses. Also, price-to-earnings multiples have fallen a lot, which is unusual in such a low-inflation, low-bond-yield environment. These relationships suggest the stock market should hold its own and should go up. That leaves open the critical economic policy issue: job creation.

Disclosure: No positions