How the Economy Will Look On Election Day

A lot can still happen before the midterm elections in November. But one thing that's probably safe to rule out is a dramatic improvement in the economy.

In fact, there's a good chance the economy has already peaked for the year, and that has dire implications for President Obama and Democrats hoping to maintain control of Congress. Many Americans probably didn't notice, but the economy grew by about 3.5 percent over the last 12 months. Forecasting firm IHS Global Insight thinks that growth peaked in the second quarter, at about 3.8 percent. Those would be healthy numbers in a normal economy. But much of that growth came from government stimulus spending, the first-time home buyer tax credit, huge capital injections by the Federal Reserve, and other fairy dust sprinkled on the economy by Washington.

[See 10 states where taxes are up, services down.]

The government's potions are starting to wear off. The stimulus spending will gradually wind down over the next couple of years. The Fed has ended its biggest financial maneuver, meant to juice demand for bonds, stocks, and other securities. After being extended once, the home buyer tax credit has expired for good. And with the huge national debt becoming a problem in itself, Congress has begun to shut the door on further requests for aid to the unemployed, strapped state governments, and other supplicants.

Economists are waiting for the private sector to seize the baton, which is what usually happens as the economy heals from a recession. But the private sector isn't getting the message. Hiring remains weak. Home sales have tumbled, despite the lowest mortgage rates in 50 years. Consumers worried about their jobs aren't spending enough to bounce the economy out of its rut. IHS chief economist Nigel Gault foresees "a subdued recovery by historical standards," with growth slowing to just 2.5 percent in the second half of 2010.

[See 5 reasons a double-dip recession could happen.]

Incumbents clinging to their seats—especially Democrats defending President Obama's agenda—will accentuate the positive: At least the economy is growing. Aggressive government action averted a depression. It could have been a lot worse. That's all true, but good-enough arguments will sound unconvincing in November, when the economy will still feel pretty scary. Here's how some key indicators will look on Election Day:

The unemployment rate, which is 9.5 percent now, will probably be higher. It might even cross the unnerving 10 percent threshold again. In a way that would be a good thing, signaling that the most discouraged jobless people—the ones who gave up looking for work—have regained hope and started job-hunting again. But it's hard to rationalize high unemployment as good news, especially amidst the political sophistry of an election.

The stock market will continue to be volatile. It's practically impossible to predict whether stocks will go up or down, but there's a plausible case for a bear market that could easily last until November or later. Some theorists believe the huge rally that lasted from March of 2009 to April of this year was artificially driven by government intervention—especially the Fed's maneuvers, which are now mostly over. And it makes sense that the stock market would take a breather as economic growth slows. This matters for politicians because the direction of stocks directly affects whether voters, particularly those with retirement accounts and investment portfolios, feel better or worse off.

[See how the markets outran the economy.]

European debt problems will probably get worse before they get better. The big bailout for Greece, brokered in April, temporarily stopped a panic, but underlying problems remain and they still haven't been addressed in bigger countries like Spain and Italy. Even worse, some European countries seem headed back into recession, which will intensify the strains. Europe's debt problems matter here because any risk of default triggers fears of contagion, forcing banks everywhere to restrict credit and raise lending rates. That would torpedo the stock market, raise operating costs for companies, and further crimp spending and hiring.

[See what Washington needs to learn from Greece.]

Financial and healthcare reform might represent bragging points for activist Democrats, and sweeping new legislation may very well do some good down the road. But there will be few tangible results by November. Meanwhile, the complexities of new and proposed regulation have added to compliance costs and reduced profitability in sectors like finance and insurance that employ a lot of Americans. On Election Day, the perceived pain may outweigh the potential gain.

[See 4 things financial reform won't do for you.]

A double-dip recession will still be a headline worry. And expect Republican challengers to seize on the hype. Most economists think a double-dip is unlikely, but economic forecasts have been getting weaker, not stronger, and Lord knows the prognosticators have gotten it wrong recently. After steady improvements, consumer confidence has taken a startling U-turn, heading back toward recession levels. A terrible housing market and weak consumer spending doesn't leave much else to fuel a recovery. And the government, which has kept the economy afloat, is out of money.

The question for November isn't whether the gurgling economy will produce Republican gains. That seems inevitable. The question is whether Republicans will regain control of Congress—and if they do, then what? Political analyst Larry Sabato, for one, predicts that Republicans will gain 7 seats in the Senate and 32 in the House—enough to stymie most Democratic plans, but not enough to regain control of either chamber. If that's what happens, Republicans might consider it a blessing. The economy isn't looking so great in 2011 or 2012 either, and the next Congress is going to have to confront the inevitable need for tax increases and spending cuts. Maybe we'll get used to throwing the bums out every two years.