The biggest threat to the economy over the next five months isn’t the housing market, consumer confidence, or the European debt crisis. The greatest worry? Congress. Yes, 535 lawmakers could set back the slow-to-recover economy with a blunder or two in this fall’s fiscal battles, which provide many opportunities for missteps—from negotiations over another round of spending cuts to fights over raising the debt ceiling.
That’s the message President Obama and Federal Reserve Board Chairman Ben Bernanke delivered recently. “As long as Congress doesn’t manufacture another crisis—as long as we don’t shut down the government just as the economy is getting traction, or risk a U.S. default over paying bills we’ve already racked up—we can probably muddle along,” Obama said this week. Bernanke told the House Financial Services Committee last week, “The risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect.”
Economists agree. “The biggest macroeconomic threat is what is happening in D.C.,” says Justin Wolfers, a professor of economics and public policy at the University of Michigan. “The more you play silly games with the economy or the credit rating, the more likely it is that Congress will mess up accidentally and drive the economy over the cliff.”
That’s too bad for voters and consumers, because other economic indicators are improving. The sale of new homes in the U.S. climbed 8.3 percent in June, the biggest increase since May 2008, according to Commerce Department data. Consumer spending also increased by 0.3 percent in May, thanks to more Americans purchasing cars, sporting goods, and home-improvement items. Even personal income rose 0.5 percent in May, up from April's 0.1 percent increase.
But those data points can’t forestall some looming problems. The first threat comes from sequestration, which will roll into the next fiscal year on Oct. 1. Those economic effects are easy to quantify: The Congressional Budget Office and private forecasters estimate that the spending cuts, which took effect in March, have already cost the economy roughly 1.5 percentage points in economic growth and as many as 750,000 jobs.
That means that the gross domestic product is growing only 1.8 percent, according to the latest data from the Commerce Department, when it could be humming along at more than 3 percent. And the full weight of fiscal drag, caused by the sequester, tax increases, and budgetary spending caps, is expected to last through the fourth quarter of 2014, assuming Congress does not enact any additional spending cuts or tax increases, says Brian Kessler, an economist at Moody’s Analytics.
Later this fall, Congress will encounter the second economic threat: brinkmanship over the national borrowing limit, which lawmakers must raise by sometime in October or November. This once-routine maneuver became a political cudgel in the summer of 2011, when Republicans used it as a way to protest multiple years of an annual deficit exceeding $1 trillion.
The last major showdown spooked investors, consumers, and the stock market, according to economists. The Dow Jones industrial average dropped more than 1,000 points starting around July 25 that year. Consumer confidence plummeted lower that month than it had after the collapse of Lehman Brothers in 2008, Wolfers says. “Two years ago, with the debt-limit saga—it clearly affected the confidence numbers, and it started to filter into the spending data as well,” says Jim O’Sullivan, the chief U.S. economist for High Frequency Economics, a forecasting firm in New York.
It’s unclear whether Congress will push the debt-ceiling negotiations to the last minute, as it did in 2011, although lawmakers do seem to be laying the groundwork for a major fight. Neither the financial community nor consumers seem particularly concerned yet, says Joshua Feinman, chief global economist for Deutsche Asset & Wealth Management. “It’s looming out there, but the markets are not focused on it, partly because it’s a few months from now and partly because they’ve seen this movie before.”
The potential economic threats this fall, combined with lawmakers’ inability to manage entitlement spending over the long run, could coincide with other structural economic problems over the next decade. For example, the number of women entering the workforce will plateau in the coming years. Baby boomers will begin to retire en masse. These slow-moving trends are already expected to soften the economy by 1 percent from 2019 to 2023, falling from an average rate of growth of 3.3 percent to 2.3 percent, according to CBO. If Congress keeps up the budget fights, eventually the battles will bump up against bigger factors that will hamper growth.
And there are still other potential problems. “To be honest, we have enough scary stuff happening in the near-term future,” Kessler says. “The things that keep me up at night are the sovereign-debt crisis in Europe that’s far from resolved or the sustainability of the housing recovery.”
For now, housing data look promising. Consumer spending rose in May, and the job market seems to be improving. But the economic recovery is still precarious and slow. There is not much margin for error, and Congress has been a bit cavalier when it comes to the economy, favoring politics over concrete solutions that lawmakers can enact. If members aren’t careful, they could vindicate Obama and Bernanke—just in time for the 2014 election.