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Goldman Sachs Analysis Highlights Tripwires for U.S. Economic Policy in 2012

The Price of Oil, Tight Fiscal Policies, and the European Debt Crisis

SOURCE: AP/Manuel Balce Ceneta

An American flag waves outside the U.S. Capitol Building, where elected officials will have to work together to help our economy grow and recover.

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The latest economic prognostication for U.S. economic growth in 2012 from analysts at Goldman Sachs Group Inc. is essentially pessimistic—forecasting about 2 percent real economic growth (after accounting for inflation) for the year. That would be tolerable if the economy wasn’t still climbing out of the big hole dug by the Great Recession. To emerge from that hole, we need to do better.

Broadly speaking, the Goldman Sachs analysts see a repeat of 2011 with some job growth but not as much as we need, stagnating incomes, and general sluggishness. But what’s more interesting than this bottom line are the three contributors they highlight as providing the headwinds:

  • Tight, and tightening, oil supplies
  • Contractionary fiscal policy
  • Spillovers from European crisis

So what are the correct federal government policy actions that could improve the situation? In two of the three cases, they are actually rather clear—the problem is how to actually make them happen.

The most unclear area is Europe. There are certainly ways the United States can help the Europeans sort out the mess they’re in, but it really is predominantly something the Europeans will have to work out for themselves. It’s a European political, and politicized, problem as much as an economic/fiscal/financial one.

With respect to rising oil prices, however, there are feasible solutions. While tight and tightening oil supplies are something that the private sector will adapt to in time, there are steps the federal government can take to minimize the economic pain in the process and reduce the drag on growth. No, the answer isn’t making it easier to access fossil fuels on U.S. soil and in U.S. waters—there just isn’t enough oil here to make a noticeable difference on the cost of globally priced fuels.

The answer is to take steps to reduce consumption of oil in the United States, sheltering our economy from the impact of rising prices. Cash-for-clunkers, investments in alternative energy, subsidies for electric vehicles, and other measures can help. But many of the measures taken in the past have expired as the American Recovery and Reinvestment Act of 2009 and other efforts have sunsetted. And sadly, there is little chance of them being revised with the current atmosphere in the House of Representatives: blocking even measures that would require more energy efficient light bulbs.

So federal government policy is going in exactly the wrong way in this case.

Likewise, federal policy is going in the wrong way with respect to fiscal policy. While in the long run we have to deal with the federal budget deficit, in the short run, cutting government spending is hurting the economy and strangling the recovery. Goldman Sachs predicts that even if the payroll tax cut is continued and emergency unemployment benefits are maintained beyond the currently agreed on two months—which is by no means guaranteed given House resistance—fiscal tightening will knock three-quarters of a percentage point off of growth in U.S. gross domestic product, the largest measure of growth in our economy.

That’s not helpful.

We obviously can’t count on low taxes and elevated government spending to sustain our economy forever, but this is not the time to be overreacting to immediate budget deficits. We can afford to wait until the most problematic temporary barriers to growth are sorted out, such as when the housing market bottoms out and is firmly recovering, and when the European situation stabilizes. With the interest the federal government is paying on its debt at such low levels right now, it is in fact an excellent time to be borrowing. And the payoff in economic growth, which we need to truly address our debt problem, is well worth it.

That is not, however, current federal policy. Instead, the debt limit deal in 2011 reduced spending in 2012 and put in place even more drastic cuts for 2013. There should be a plan for addressing our nation’s fiscal challenges. But it should be a plan where the action comes in later years.

That is not where the House of Representatives, or at least the controlling Tea Party caucus, is. And it means that 2012 will, sadly—and unnecessarily—be a weaker economic year, whether as bad as Goldman Sachs predicts or not, than need be.

Michael Ettlinger is Vice President for Economic Policy at the Center for American Progress.

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