ECONOMIC INSIGHTS

The specter of a lame-duck Congress after the U.S. presidential election may irritate voters calling for faster moves to bring down the jobless rate, cut the budget deficit and keep the economy from slipping back into recession. But it may not make much real difference in economic performance.

"The paralysis in Congress, likely to last for the balance of this election year, placed additional pressure on the Fed to be accommodative," says Carl Tannenbaum, chief economist at Northern Trust. "Unfortunately, political forces are likely to defer budgetary resolutions here and overseas. The debate between austerity and stimulus is a passionate one, with consensus seemingly far off."

Headed into the November 6 runoff, the economy is uppermost in many taxpayers' minds. They fear that the soft recovery could lose even more strength and slip back into another recession, pushing back up the 8.1% U.S. jobless rate. Mindful that major European economies already have lagged into recession, voters clearly remain on edge.

With activity faltering, the U.S. central bank felt compelled to act quickly and substantially. The Federal Reserve decided in mid-September to extend its quantitative easing program by announcing it would purchase $40 billion a month of mortgages to help shore up the flagging economy and bring down the jobless rate.

News of the central bank's third round of quantitative easing sparked criticism from some quarters that QE3 could camouflage a political agenda designed to boost the equities market into the election and ultimately could prove negative if inflation expectations ratcheted upward and remained elevated.

Northern Trust's economists, however, doubted QE3 would trigger sustained inflation fears. "It will be important to keep a close eye on inflation and inflation expectations, as the Fed's ability to maintain QE3 could eventually be restricted if the price level begins to escalate more rapidly," says Asha Bangalore, senior vice president and economist with Northern Trust. She notes, however, that inflation expectations posted large fluctuations after two of the three rounds of quantitative easing were announced, only to recede to more non-threatening levels. This time, "our view is that inflation is unlikely to breach the Federal Reserve's target level of 2% anytime soon, and that expectations will eventually come into line with this," she says.

Comments accompanying the open-ended easing made it clear that the Fed's focus is also trained on the labor market, not a surprise given that maximum sustainable employment is one of the Fed's mandates. "For the first time, policy actions have been tied directly to job readings," says Tannenbaum. "This association certainly makes sense, but some will likely feel uncertain about exactly what constitutes 'substantial' improvement. To us, though, tying QE3 to an economic target variable seems like a meaningful formulation."

Regardless of voter sentiment, political jockeying on both sides of the aisle is expected to stymie forward movement by politicians on fiscal issues. That means the economy may still teeter on the edge of the so-called "fiscal cliff" on December 31, because Congress is apt to do nothing until early 2013.

Still, any temporary inaction may make little difference in an already soft economy. "We do not expect the impending fiscal restraint at the federal level to damage the economy with full force," Tannenbaum adds. "While the cliff will be a noticeable distraction in the near term, the likelihood is that legislators will eventually smooth some of its rougher edges. Nonetheless, the downward trajectory of federal, state and local government outlays will continue to limit economic performance through the forecast period."

COVER STORY

Quality Matters

The search for quality can be worth the extra effort

» read article

DEPARTMENTS

FUND PROFILE

Wise Beyond Their Years

Forged by earlier crises, young emerging markets show signs of maturity

» read article

 

MARKET VIEWPOINT

Perspective

Analysis on market segments and overall market outlook

» read article

 

ECONOMIC INSIGHTS

Lame-Duck Congress: Does the Economy Budge?

Lack of changes in fiscal spending and policy until after the presidential election may have little impact on the U.S. economy after all

» read article

NORTHERN FUNDS