Barely six months in office, President Obama already finds himself in an economic box. For despite his aggressive and costly economic policy initiatives, the jobs market shows no sign of healing. At the same time, the housing market foreclosure crisis continues apace, while renewed questions are again surfacing about the soundness of the U.S. banking system. To complicate matters, financial markets are now starting to fret about the longer-run inflationary consequences of the unusually large budget deficits in prospect for as far as the eye can see.  

In January 2009, on presenting its $780 billion fiscal stimulus package, the Obama administration assured the public that because of that stimulus package U.S. unemployment would not exceed 8 percent. Yet already by June 2009, unemployment had risen to 9.5 percent; including part-time workers, who would prefer to be working full time, unemployment rose to a staggering post-war high of over 16 percent. Worse still, the jobs market shows every sign of being far from bottoming out.

The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach.

The degree to which unemployment has exceeded the administration’s forecasts has to raise basic questions about the appropriateness and coherence of President Obama’s economic policy approach. These questions pertain not simply to the very poor design of the fiscal stimulus package. Rather they pertain to the adequacy of the measures aimed at stabilizing the housing market and at resolving the country’s most wrenching credit crisis in the post-war period.

At the most basic level, one has to question how much sense it made for President Obama to allow the fiscal package to become excessively back-loaded at time when the economy needed immediate large scale support. If a large fiscal stimulus was indeed needed, why has only $60 billion of that package been dribbled out by June? And why is less than a third of the package scheduled to come into effect in 2009, the year when the package is most sorely needed?

Similarly one has to wonder about the heavy price that the Obama administration paid for effectively outsourcing the package’s design to House Speaker Nancy Pelosi and the rest of the Democratic congressional leadership. Should it really have come as a surprise to us that the resulting stimulus package would be laden with pork and with expenditures that are going to be very difficult to roll back? Or should we now be shocked that the package fell sadly short of including fast acting and effective fiscal stimulus measures that might have gotten the most bang for the buck?

Perhaps the most troubling aspect of the Obama fiscal stimulus package is the serious way in which it compromises the country’s long-run public finances and fans long-run inflationary expectations. The nonpartisan Congressional Budget Office estimates that the Obama budget not only implies unusually large budget deficits over the next two years but it implies that, even when the economy eventually fully recovers, the deficit will remain in the region of between 4 and 6 percentage points of GDP. As a result, over the next decade, the public debt will rise in a manner that has never occurred before in peacetime, from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

Over the next decade, the public debt will rise in a manner that has never occurred before in peacetime from around 41 percent of GDP in 2008 to 82 percent of GDP by 2019.

The rising tide of unemployment must also raise questions about the Obama administration’s efforts to stabilize the housing market, which the administration correctly views as a necessary condition for producing a meaningful economic recovery. One has to expect that a weaker job market will only exacerbate the country’s present foreclosure crisis, which is adding supply to an already glutted housing market. The Center for Responsible Lending estimates that 2.4 million homes could be in foreclosure in 2009 and as many as 8.1 million homes over the next four years. Yet, the Obama administration’s loan modification program announced earlier this year has to date only resulted in 190,000 offers at mortgage loan modification.

Rising unemployment also has to raise questions about whether the Obama administration is not being overly sanguine about the health of the U.S. banking system. For it would seem that unemployment will now well exceed the worst-case scenario in the bank stress test presented by the administration earlier this year. Yet, despite a weakening unemployment outlook that is sure to boost bank losses, the Obama administration is now cavalierly backing away from its earlier initiatives to reduce the toxic assets that remain on the banks’ balance sheets.

Less than six months into his term, President Obama already faces difficult economic policy choices. He can choose, as he now seems to be doing, to counsel patience and assure us that all is well at considerable cost to his credibility on economic policy management. Or he can own up to the facts that he misread the economy in January and that his economic team now needs to go back to the drawing board. For the sake of the U.S. economy, one has to hope that he has the courage to review the overall coherence of his policy approach before it is too late.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was managing director and chief emerging market economic strategist at Salomon Smith Barney and a deputy director in the International Monetary Fund’s policy and review department.

FURTHER READING: Lachman wrote “Does Bernanke Really Deserve a Second Term?” and “Despite the Doubters, It’s Still Top Dollar” on the likelihood that the Chinese renminbi will eventually replace the U.S. dollar as the world’s preeminent international reserve currency. He also penned “Can the IMF Really Save the World Economy?” and “The World Economy’s Europe Problem.” His article “Don’t Repeat Japan’s Mistakes” warns against the policies Japanese authorities followed during their financial crisis in the early 1990s.

Image by Darren Wamboldt/Bergman Group.