The first is that we will be gripped by the austerity movement that has captured Europe and that, as a result, we will withdraw stimulus too soon. Republicans have been promoting policies to reduce the deficit for some time now, spending cuts in particular are on the agenda. Many among the Republican leadership would have canceled the remaining stimulus already, including extensions to unemployment insurance, if they were in control.
If Republicans make big gains, as it appears they will, these calls to balance the budget will grow louder and they will be echoed by Blue Dog Democrats. If Obama could be trusted to veto any such initiatives, my concern would be eased. But it's not at all clear that Obama won't trade spending cuts for progress in other areas, for example environmental legislation. His actions to date reveal a tendency to compromise rather than draw lines in the sand, but this is not an area where compromise is the right approach. A movement to balance the budget too soon sent the economy into a tailspin in 1937-38, and the same could happen today if we begin withdrawing stimulus too soon. The time will come to do reduce the deficit, and we should plan for it now, but moving on the plan too soon could be disastrous.
The second concern is related to the first. I expect that we will have a slow, agonizing recovery, particularly for employment. I do not expect a double dip, but it's not out of the question by any means, and we need to be ready in case it happens. Unfortunately, the election is likely to bring gridlock and it's doubtful that Congress will be able to act in response to a second downturn. An increase government expenditures in response to a slowdown is certainly off the table. It's hard to imagine Republicans who have argued -- wrongly in my view -- that the stimulus did not help the economy getting behind increased spending.
So that leaves tax cuts. However, tax cuts are known to be poor stimulus, there will likely be a hidden agenda to make them permanent once they are in place, something that would make the deficit problem even worse, and the tax cuts would likely be skewed toward Republican interests. Democrats might go along just to get something done in response to a second double dip, but there's a bigger chance that they wouldn't given the nature of the tax cuts that Republicans would be willing to accept. Congress is most likely to be gridlocked, there will be no new spending and no new tax cuts in response to a double dip, and the economy would be left to struggle to recover on its own.
But my biggest concern is what will happen if new problems emerge in the financial sector. The resolution authority in the Dodd-Frank legislation is supposed to prevent the need for another financial bailout, but I am not at all confident that this will be sufficient to solve widespread problems and threats of failure in the banking system. There's a good chance that the resolution authority won't get the job done and that a bailout will be the only way to resolve severe problems. However, if problems do arise and another financial bailout is needed, forget it. Opposition to the banking bailout makes it nearly impossible for Congress to undertake another bailout of the financial system.
The problem is that the bailout rewarded those who caused the problems, while not doing enough for innocent bystanders hurt by the banking crisis and recession. There is a lot of resentment over the bailout for that reason, and a lot of sentiment that we would have been better to just let the banking system burn to the ground. It wouldn't have been better, a banking collapse would have likely caused a depression rather than a Great Recession, and these sentiments could have been avoided in any case. It would have been possible to distribute the benefits differently and give the general public a larger share, and to toss out the management of the banks that caused the problems rather than saving them. But it's too late to turn back the clock now.
As far as economic policy is concerned, gridlock is in our future. A very slow recovery is likely, and there is little chance that Congress will try to speed things up through new policy initiatives. While that is not great news -- a multi-year recovery is certainly not what we'd like -- let's hope that's as bad as it gets. Because if there's another financial meltdown, or a double-dip recession, Congress will not provide the help that is needed, and that could be catastrophic.