U.S. Economy Pulled Down by More Than Iraq

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WASHINGTON, March 28 (UPI) — Even if the war against Iraq does end relatively swiftly, the U.S. economy may not recover as quickly as some investors might hope, economists cautioned Friday.

“Geopolitical risks are not going to decrease with the end of Saddam (Hussein),” said Michael Prell, former research director of the Federal Reserve Board. He pointed out that the ongoing war was more about fighting terrorism, rather than simply trying to topple the current Iraqi government.


As such, Prell said that war risks were unlikely to decrease significantly even when Saddam is ousted from power, and added that concerns about or indeed an outright terrorist attack could damage U.S. growth prospects much more than war against Iraq.

His comments directly challenge the belief held by many Wall Street investors, who are expecting the economy to return to a steady growth path once the war against Iraq is over in a few months’ time, as is now widely speculated. Indeed, such optimism was expressed by Treasury Secretary John Snow as recently as this week, as he said he expected share prices to climb steadily once the war was over.

But the former Fed economist dashed such hopes, as he told economists and policymakers at a briefing that even without a war in the Middle East, or even the Sept. 11 attacks or threats of future terrorist activities, the U.S. economy would have languished as a result of the excesses of the late 1990s, and that the problems accumulated then are continuing to bog down growth potential.

The economy had already been languishing when terrorists struck New York and Washington in September 2001, as investors were still smarting from the burst of the high-tech bubble. But Prell said that financial markets still had some ways to go down south before they were fully adjusted for the over-exuberance of the past decade, suggesting that stock prices were still over-valued despite the continued downward trend of equities over the past two years.

Meanwhile, Eric Engen, an economist at the American Enterprise Institute and former Fed economist, agreed that economic fundamentals have been weak since the peak of expansion was reached in March 2001, and cautioned that an end to the war effort would not necessarily spell an automatic rebound for U.S. growth prospects. Both former Fed economists were also wary of the possibility of oil prices remaining high should political uncertainties in the Middle East remain, which in turn could fan the flames of inflation and keep a lid on both business and consumer spending.

But unlike Prell, Engen said that President Bush’s fiscal policy, as well as monetary policy currently being pursued by the Fed, were conducive enough to encouraging growth in the longer term, unlike during and after the first Gulf War.

“Policy, both fiscal and monetary, are looser now,” Engen said, pointing out that the key interest rate is now at its lowest level in over forty years at 1.25 percent, while the Bush administration continues to press for more spending. In 1991, interest rates were high, with the federal funds target rate averaged 5.7 percent, whilst it was averaged at 8.0 percent in 1990. At the same time, inflationary pressure is of little concern to policymakers to date, whilst it was a considerable source of anxiety a decade ago.

As for federal spending, Engen argued that the budget restraints imposed by President George H. Bush, followed by President Bill Clinton’s fiscally restrained administration, had actually cramped the ability for the economic growth engine to ignite sooner than it could have. Thus, Engen concluded that President George W. Bush’s efforts to continue cutting taxes and bolster spending would ultimately benefit the country’s economic outlook.

There is, of course, the possibility that the Fed could cut rates still further to stimulate the economy, and the former research director of the central bank said that policymakers may well cut interest rates to zero, even though he declined to comment on a specific timeline. Meanwhile, Fed governor Ben Bernanke said at a conference this week that the central bank should consider adopting an inflation targeting scheme, given that deflationary as well as inflationary pressure could potentially hurt the economy.

But not all economists were as pessimistic about the U.S. economic outlook. Kevin Hassett, who was also formerly a Fed economist, said that the economy picked up after the Gulf War, albeit with a time lag of a few years.

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