Consumer sentiment highlights risks to recovery

Consumer sentiment fell more than forecast this month, highlighting the risks to the economic recovery. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment released Friday morning fell to 72.5, from 75 in January. Historically, this measure is tied closely to the price of gasoline, which has risen in recent weeks. The stock market turned slightly lower when the number was released.

The dip in consumer confidence contrasts with Thursday's positive economic news, that new claims for unemployment insurance had fallen to 358,000; yet another indication that labor markets are headed in the right direction. But while things are looking up, there are still risks ahead and policy mistakes to be avoided.

For example, there are still risks from the situation in Europe, and there are also risks that oil prices will rise due to trouble in the middle East. However, the main concerns I have are about the speed of the recovery -- at present rates we won't reach full employment for many years yet -- and the chance that monetary and fiscal policymakers will reverse course too soon due to inflation and deficit fears and slow the recovery even further.

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We are still in a deep, deep hole and though we are beginning to climb out of it, there is still a long way to go. Things are better, but we shouldn't let those pushing for austerity use the recent good news as an excuse to enact deficit reduction before the economy is ready. Presently, the economy needs policies that boost economic growth, not policies that work against it. At the very least Congress needs to have the patience to delay deficit reduction until the economy is on better footing.

There is also a danger that the Fed will begin raising interest rates too soon. Whenever the economy shows any signs of life the inflation hawks within the Fed begin to worry and start pushing for tighter monetary policy. Many within the Fed seem to recognize that policy cannot be tightened anytime soon, but there is certainly another contingent pushing for an earlier schedule for rate increases and good news could change the current sentiment for patience.

The news has been better lately, no doubt about that, and the improved outlook for the future ought to increase both consumer spending and business investment. But risks remain. Some of those risks are largely out of our control, but some are not -- monetary and fiscal policymakers can choose the policy to pursue -- and policymakers must realize that the economy is still in a fragile state. That will change eventually, we are headed in the right direction, but for the moment it's important not to take policy actions that make it harder for the economy to regain a solid footing.