What the listless economy needs now

Despite short-term interest rates that hover near zero and almost $1.5 trillion of bailout spending through the Troubled Asset Relief Program and the administration’s stimulus program, the economy is still weak. Why?

Let us count the reasons, which are interrelated.

The economy is weak because consumer demand is weak. With little reason to generate greater output, companies aren’t ordering as much from their suppliers, who in turn slow down their own hiring, investment and business activity.

Consumer demand is weak because consumers are paying down debts, saving to rebuild their shaky finances, are unemployed or are fearful of becoming unemployed.

Because consumer demand is weak, many businesses are cutting capital investments, not hiring, and still reducing staff in some cases.

Even if demand were to pick up, small businesses likely would be slow to hire additional employees, as they would face additional costs from health care reform. If a business doesn’t offer health insurance, the new law allows the company to avoid fines if it keeps the number of employees below 50.

Small businesses face additional taxes in 2011 after the Bush administration tax cuts terminate Dec. 31. Many small businesses are Subchapter S corporations, so increases in personal income taxes hit them hard.

There also is the prospect of higher energy costs if any form of cap-and-trade legislation goes into effect, which would pose a problem for energy-intensive manufacturing businesses.

Even if they want to expand, many small businesses can’t get the financing that they need from their local banks. Because banks know that the financial-reform law will require them to set aside higher reserves, they are husbanding those reserves.

At the opposite end of the business landscape, many large corporations are flush with cash, which they are hoarding because of the economic uncertainty. No chief financial officer wants to be short of cash when faced with a debt repayment at a time when the capital markets are frozen, as in September 2008.

So despite the stimulus and extremely low interest rates, the economy seems poised to enter a period of prolonged weakness. Policy advisers who have spent their lives dealing with the threat of inflation are ill-prepared to cope with its polar opposite, deflation.

There is no easy way out. The economy probably needs more stimulus, but because government spending and credit creation to this point have produced ballooning deficits with only meager results, many in Congress, and many voters, balk at more of the same.

More deficit spending, in fact, may be counterproductive because it could signal even higher taxes and inflation than individuals and businesses already anticipate — leading them to back up on spending even further. Of course, additional stimulus spending might work if individuals and businesses create a credible plan for reducing deficits once the economy recovers sufficiently.

Unfortunately, President Barack Obama addressed this concern too late, naming a deficit commission only recently and asking that it report after the November elections. The commission seeks to be making progress toward a bipartisan list of proposed spending cuts and tax increases which could reassure the nation that Washington is serious about the deficit and that the country isn’t in danger of becoming another Greece.

We need the commission’s proposals — assuming that they are accepted by the Obama administration and both parties — now in the dog days of summer when the economy is wilting, not months from now.