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Beware Another Round Of Green Shoots

The unemployment numbers released at the end of the week are likely to be the best of the Obama Presidency. They may even show an increase in jobs for the first time since 2007. US manufacturing activity clocked in at a four-year high today. The GDP report is bound to be solid as well, at least in terms of showing economic growth. Stocks are soaring in this first trading session of 2010.

Paul Krugman explains why everyone needs to keep their heads over this.

As you read the economic news, it will be important to remember, first of all, that blips — occasional good numbers, signifying nothing — are common even when the economy is, in fact, mired in a prolonged slump. In early 2002, for example, initial reports showed the economy growing at a 5.8 percent annual rate. But the unemployment rate kept rising for another year.

And in early 1996 preliminary reports showed the Japanese economy growing at an annual rate of more than 12 percent, leading to triumphant proclamations that “the economy has finally entered a phase of self-propelled recovery.” In fact, Japan was only halfway through its lost decade.

Two things are helping the economy right now: an “inventory bounce” caused by production having to ramp up again after unsold goods were finally pushed out the door, and stimulus spending, which is nearing its peak right now. When the inventory gets replenished and the stimulus funds run out, where exactly will the economy be? As Krugman notes, housing and consumer spending remain mired at near-depths, and business investment is languishing.

The worst reaction to the short-term good economic news would be to put additional support measures on hold. Conservative economist Martin Feldstein is sending warning signals that more stimulus is required:

Harvard University economics professor Martin Feldstein said U.S. economic growth may falter this year because of a waning stimulus from federal spending and tax incentives for purchases of homes and autos.

“These forms of stimulus will be missing in 2010, creating a serious cloud over the near-term economic outlook,” Feldstein said yesterday during a panel discussion in Atlanta sponsored by the Allied Social Science Associations. His comments were echoed by Joseph Stiglitz, the Nobel Prize-winning economist, who said on the same panel that “robust” growth is unlikely soon […]

“It will be difficult to have a robust recovery as long as the residential and commercial real-estate markets are depressed and local banks around the country restrict their lending” because of default risk, Feldstein said.

As Krugman said in a speech to the same economics conference, the US actually hasn’t handled this particular crisis well.

Fiscal stimulus has been inadequate, financial support has contained the damage but not restored a healthy banking system. All indications are that we’re going to have seriously depressed output for years to come. It’s what I feared/predicted in that 2001 paper: “[I]ntellectually consistent solutions to a domestic financial crisis of this type, like solutions to a third-generation currency crisis, are likely to seem too radical to be implemented in practice. And partial measures are likely to fail.”

Maybe policymakers will become wiser in the future. Maybe financial reform will reduce the occurrence of crises: major financial crises were much rarer between the end of World War II and the rise of financial deregulation after 1980 than they were before or since. Meanwhile, however, the fact is that the economic world is a surprisingly dangerous place.

Longer-term economic success, which is tied to Democratic electoral fortunes, almost certainly would require more public investment in the form of a jobs bill. That holds regardless of this week’s economic numbers.

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David Dayen

David Dayen