Huge cuts could imperil recovery, economists say

August 03, 2011|By Megan Woolhouse, Globe Staff

The massive federal spending cuts that will follow the deficit reduction deal could further weaken a national economy that has been rapidly losing momentum, economists said.

While few forecast an imminent downturn, they said the withdrawal of hundreds of billions of federal dollars comes at a bad time. Over the past few months, hiring has ground almost to a halt, the unemployment rate has resumed an upward trend, and overall economic growth has been barely positive.

Yesterday, the Commerce Department reported that consumer spending, which accounts for more than two-thirds of the nation’s economic activity, fell for the first time in nearly two years.

“That was a surprise it was so bad,’’ said Kenneth Rogoff, a Harvard economics professor. “If consumption is weak, what are businesses going to do? We’re certainly at a vulnerable point.’’

Stocks plunged yesterday on fears of a weakening economy, with the Dow Jones industrial average losing more than 265 points. It was the eighth consecutive day of declines, the longest losing streak since October 2008, during the financial crisis.

Persistently high unemployment above 9 percent and a fear of additional job losses also weigh heavily on consumers, who dramatically reined in their spending; between May and June, the nation’s savings rate rose from 5.0 to 5.4 percent. The weak economy, further hurt by a stagnating housing market, has raised concerns that the nation could slip into a second, or double-dip, recession.

The last double-dip recession occurred in 1981 after the Federal Reserve pushed short-term interest rates as high as 20 percent to fight runaway inflation. However, several economists said the nation’s current economic situation bears more likeness to a period leading to the recession of 1937-38, which came on the heels of the Great Depression.

In both cases, lawmakers and policy makers, concerned about government deficits, took steps to curb federal spending when the economy was still weak.

Gary Richardson, an economist at the University of California at Irvine and a scholar of the era, said unemployment rates soared to 19 percent in the year after the Roosevelt administration raised taxes and cut government spending and contracts as a way to solve the country’s long-term deficit problem.

“Sadly in the last three days we have repeated the biggest policy mistake of the Roosevelt administration … cutting government expenditures in the midst of prolonged high unemployment,’’ he said. “It’s certainly not going to help the recovery.’’

Richardson said political leaders have failed to address the long-term economic questions, such as whether the government can continue to fund Social Security and Medicare benefits at promised levels.