What to Do if the Economy Tanks

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The White House has offered a pretty upbeat assessment of the economy heading into 2007: steady 3 percent growth, falling inflation, and continued low unemployment. But what if Team Bush is wrong? What if the U.S. economy slips into a recession or a period of sluggish growth with rising unemployment in 2007, perhaps because of the housing implosion? What should be done about it? To find out, I E-mailed some smart thinkers–all of whom also write must-read blogs. Here is what they told me.

Dean Baker, codirector of the Center for Economic and Policy Research. Writes the Beat the Press blog: "This would be a real tough one because the proximate cause of the downturn is the collapse of the housing bubble, and I really don't think that it is helpful to stop or slow the unwinding of the bubble even if we could. ... Having said that, I do think it is important to try to find ways to boost the economy, but I would not look to interest rates as the best mechanism. One obvious way to boost the economy would be to push down the value of the dollar, giving a boost to net exports. Our trading partners will not like this, but it has to happen at some point, and this would be a good time. ... On the budget side, there are some things that could be done with fiscal policy. I think the recent history actually supports the case that short-term tax cuts work (look at the jump in spending when the tax rebates were mailed out in the summer of 2001). So, I think that a tax rebate sent to low- and moderate-income people can be an effective way to sustain demand (e.g., $500 per adult). ... Finally, this would be a very good time to push through a set of conservation measures that could create jobs. For example, large subsidies for retrofitting buildings for energy efficiency, installing solar panels, wind power, etc. The federal government can offer generous one-time subsidies (e.g., 40 percent tax credits) for these measures if implemented in a two-to-three-year time horizon. This would be good for the environment, it could help to give a big boost to these industries so that they would be more competitive even without the subsidies, and it would employ a lot of construction workers who are likely to be especially hard hit by the collapse of the housing bubble."

Donald Boudreaux, chairman of the economics department at George Mason University in Fairfax, Va. Cowrites the Cafe Hayek blog: "I'm quite confident in saying that the best course of action would be for government to cut spending significantly. While such spending cuts might intensify the downturn in the short run, if they are significant enough (say, at least $250 billion), that would signal less government meddling in the future and, also, the probability of further cuts in the future of explicit tax rates. The long-term benefits for the economy would be wonderful. But such significant cuts are not going to happen. Given political reality, then, the best we can hope for is that government does nothing. No "fiscal stimulus" spending and no easing of the money supply by the Fed. And, above all, no higher tariffs and other species of protectionism. If, in fact, any coming recession is the tail end of an unjustified bubble, then the inappropriate investments and other economic arrangements made by those who believed the bubble to be real must be cleared out. Delaying this clearing out with fiscal or monetary stimulus will only make matters worse in the long run."

James Hamilton, economics professor at the University of California–San Diego. Coauthors the Econbrowser blog: "If the economy does slide into a recession, I believe it would be because the housing downturn goes into free fall. At that point, the Fed would have no option but to cut rates, though rate cuts would be coming too late to prevent a recession. (My view is that fiscal policy is very rarely the policy of choice for dealing with business cycle fluctuations. By the time Congress has debated the issue and passed legislation, the situation has usually changed dramatically.) The big policy question in that scenario would be how far to cut rates. I am among many who are persuaded that the Fed often goes too far in trying to stimulate a down economy, as it certainly did in 2002–2003. Such overstimulation primarily causes new problems on the upswing, such as the inflation we're worrying about now. ... Based on the situation as I currently read it (which includes a prediction of slower growth and rising unemployment for 2007), I believe that any rate cut right now would be unwise. As for how low I'd be willing to go if instead things get much worse than that, it would really depend on the circumstances, but again I'd be cautious about trying to cut rates too aggressively."

Andrew Samwick, who was chief economist of the President's Council of Economic Advisers in 2003 and 2004 and is now director of the Nelson A. Rockefeller Center for Public Policy and the Social Sciences at Dartmouth College. Writes the Vox Baby blog: "Given the disorganized approach to both short- and long-term fiscal policy, I think we are better off leaving the management of the business cycle to monetary policy via the Fed's Open Market Committee meetings. ... The thing that Congress and the president must do is fiscal policy–no one else can do it for them. Ideally, all long-term entitlement programs are in projected long-term balance, and the non-entitlement part of the budget is in projected balance over the course of a business cycle. If we have a commitment to that ideal, then obviously fiscal policy can be loosened somewhat when a shock to the economy arrives. ... If we don't start from that position of balance, then it is very hard to give advice on what to do when an unforeseen event arises."

And as always, I love to get comments and questions. Please E-mail me your thoughts at jpethokoukis@usnews.com.