Like Wall Street, Budget Policymakers Need Certainty

Posted November 2, 2009 at 3:53pm

Wall Street, which supposedly hates uncertainty, was clearly unhappy late last week. On Thursday, in the face of a report showing not just that the economy had stopped declining but that it had actually grown faster than expected in the third quarter, the Dow Jones industrial average rallied by almost 200 points. Then, after a separate report on Friday showed that consumer spending had fallen by an unexpectedly large amount in that same quarter, the market sold off by more than the previous day’s gain as the Dow fell by about 250 points.

[IMGCAP(1)]A good report on consumer spending might have sealed the deal for the Street because it would have confirmed Thursday’s better-than-expected numbers and been convincing evidence that the economic growth was due to more than the Washington-provided stimulus. A significant second-day rally could have been expected because those with money on the sidelines would have made decisions in response to what appeared to be unambiguous information. But the conflicting reports on consecutive days created the type of doubt that makes investors uncomfortable because, despite their supposed access to better information, they aren’t really sure what is going on.

But if investors are confused about whether an economic recovery actually is at hand and, therefore, about where they should put their own money, federal policymakers must be equally as perplexed about what’s next and what they should do with taxpayer dollars.

On the one hand, the Thursday report is a strong indication that the stimulative fiscal policy in place the past two years is working and soon may no longer be necessary. On the other hand, the unexpected drop in consumer spending indicates that consumers and businesses may not yet be ready to create the level of activity the U.S. economy needs and that some federal budget intervention is still required.

I’ll leave to others the prognosticating about where the markets are heading. Besides, unlike where Wall Street is going, predicting what will happen with fiscal policy actually is relatively straightforward: A change in budget policy is coming, but not in the next few months.

The conflicting reports that so spooked Wall Street last week made it more likely that the revenue reductions and spending increases put in place by the stimulus bill adopted earlier this year won’t be reversed. If anything, the reports make it more likely that any proposals to do that will be ridiculed rather than taken seriously. Friday’s consumer spending report is almost exactly what the White House needs to justify a decision not to make any changes. In all probability, the report made economic policymakers feel even better about the current plan because, even though it might have been inadvertent rather than intentional, much of the stimulus spending and tax relief will occur in fiscal 2010 when it is still needed rather than just in 2009.

It also means that, with relatively minor exceptions, the current deficit outlook isn’t going to change much next year. The 2010 deficit will be less, and perhaps even much less, than the recession-bailout-stimulus-Iraq/Afghanistan-inflated deficit of 2009. But that reduction will be based on what’s already on the books rather than on a new deficit reduction plan.

The challenge for the White House is that, for political reasons, it needs to demonstrate that last week’s conflicting reports soon will be replaced with unambiguous statistical and anecdotal information that the economy is growing.

That will happen in two ways.

First, the White House will continue to tie positive reports together to demonstrate that, while individual results may conflict, there is an unambiguous upbeat trend that should be seen and believed.

Second, early next year the administration will demonstrate that the recovery is happening when it submits its fiscal 2011 budget to Congress with an economic forecast that confirms it with numbers. By all accounts, the budget will show the economy growing from the third quarter of 2009 through the fourth quarter of 2010 and beyond. Based on last Thursday’s stronger-than-expected 3.5 percent gross domestic product number, there are even some indications that the White House may now feel justified using a higher growth rate for 2010 than was the case before the report was issued.

This will make the release of the Obama 2011 budget one of next year’s most important economic and political events. The budget will be used to confirm what the administration has been saying would happen — that the economy is recovering and that good times are ahead. It will be both an affirmation of what has already been reported and a prediction of what’s to come.

The irony is that the Obama 2011 budget, which like all presidential budgets will be at least as much a political as an economic statement, will provide Wall Street with some of the certainty it wants. The administration’s budget not only will have a positive economic forecast, it will also show a declining deficit and won’t request any additional stimulus or bailout funds. If the forecast is realistic, that combination is likely to prove irresistible to investors.

Most important, however, if the Obama 2011 budget assumes the economy will be steadily growing at a decent level, it also will have to include a deficit reduction plan, and that will comfort investors as well. Fiscal 2011 will begin on Oct. 1, 2010 — at the start of what the White House will be projecting as the sixth consecutive quarter of growth. Postponing deficit reduction beyond then would be taken as an indication that the administration is less certain about the recovery than it is saying.

That’s not the ambiguous signal the president will want or need to send.

Stan Collender is a partner at Qorvis Communications and author of “The Guide to the Federal Budget.— His blog is Capital Gains and Games.