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Analysts, lawmakers mull 'double dip' scenario

As the economy shows troubling signs of another slowdown, some economists are beginning to worry about the possibility of a "double-dip" recession.

As the economy shows troubling signs of another slowdown, some economists are beginning to worry about the possibility of a "double-dip" recession.

While a slide back into negative growth territory is still considered remote, it is among the factors being weighed by members of Congress as they face a tough choice: whether to spend more money to bolster the weak recovery or simply hope the gears of the private sector begin turning without more government support.

Federal Reserve Chairman Ben Bernanke Wednesday said he could not rule out a "double dip" but said he expected the economy would continue to expand through next year.

While he declined to voice an opinion on additional stimulus measures being considered by Congress, he did say it was too early to begin taking the punch bowl away from the party.

"Right now I don't think is the time — this very moment is not the time — to radically reduce our spending or raise our taxes because the economy is still in recovery mode and needs that support," he said in an appearance before the House Budget Committee.

Late last month, the House passed a package of tax cuts and spending — including extending jobless benefits — but the measure is still working its way through the Senate. Mounting concerns about the swollen federal deficit have stoked opposition to the package.

But recent signs that the economic recovery may be faltering, including Friday's disappointing employment report showing a sharp slowdown in new private sector jobs, could give the measure a second wind.

"In all likelihood if we didn’t provide the stimulus the economy would still make its way through without backtracking into a recession,” said Mark Zandi, chief economist at Moody’s Analytics. “But I think the risks are too high, particularly given that it if we go back into recession, there is no response to that.”

The recession technically began in December 2007 and accelerated in 2008 with the near-meltdown of the financial sector, driven by a disastrous housing bust. Congress and the Fed flooded the financial system with trillions of dollars designed to jolt the economy back to life. When the economy as measured by gross domestic product posted solid gains beginning in mid-2009, it looked like the plan was working.

Most experts believe the recession ended sometime last year, although the official arbiters of business cycles have not yet issued a decision on the timing.

Some recent data point to an economy on the mend. On Thursday, the Labor Dept. reported that jobless claims dropped in the latest week, though a surge in temporary hiring by the Census Dept. may have skewed the data. The claims data may also have dropped as people ran out of state benefits and moved to federal programs, which aren't counted in the report, according to Barclay's Capital.

Thursday's jobless benefits data helped reverse a steep slide in stocks, pushing the Dow Jones Industrial average back above the 10,000 mark in early trading.

The latest monthly jobs data showed that private sector hiring slowed sharply in May. But the length of the average work work rose — an indication that businesses may soon convert that added work into new full-time positions.  

The economy's snapback last year was fueled by two powerful forces. After slashing production during the recession, businesses cut inventories of unsold goods to the bone. Much of the growth during the past nine months stems from a surge in production to restock shelves.

Another big boost came from massive government stimulus, including increased federal spending and monetary stimulus in the form of short-term interest rates that have been held near zero by the Fed.

But as those forces recede there are signs the economy may be losing momentum. Some economists are now marking down forecasts that had called for relatively modest growth this year in the 3 percent range.

“It’s probably too early to call for a ‘double dip,’” said David Rosenberg, chief economist at Gluskin Sheff, an investment management firm. Rosenberg added that whether economic growth slows in the second half of the year or dips into negative territory, it's "going to be disappointment either way.”

Several forces are slowing the momentum of the government’s growth policies.

Despite the Fed’s unprecedented moves to cut borrowing costs, businesses are still having trouble getting credit. The same banks that lent too freely during the housing bubble are now far choosier about who gets a loan. And they’re still cleaning up the mess on their books from the wave of easy-money lending.

"You have the federal government saying, 'Lend money,' and the regulators saying 'Strengthen your balance sheets,'" said John Kiefer, chairman of First Capital, a finance company that serves small- and medium-sized business. “You can only strengthen your balance sheet by shrinking it or raising capital. And none of the banks want to raise equity at these prices. So they're shrinking their balance sheets.”

Bankers say the credit crunch is as much a result of lack of demand for new loans as lack of supply. One big problem: the burst in production to restock inventories hasn’t been followed by a pickup in final demand for goods and services.

"From the small business sector point of view, we are still in a recession. We are not contributing to growth in the economy,” said William Dunkelberg, chief economist of the National Federation of Independent Businesses. “The big problem they have is that they don't have any customers. Weak sales. That's the top problem we face. If consumers suddenly decided to spend a lot of money, we would be doing well.”

That doesn’t appear likely. With the official unemployment rate close to 10 percent — not counting all those who are underemployed or no longer looking for work — consumers have been keeping a tight rein on spending. The number of people having trouble paying bills is still rising, according to Greg Daugherty, an editor at Consumer Reports, which conducts a monthly survey of consumers.

“The last couple of months looked pretty good, but this month there are some numbers that are not so great,” he said. "I think consumers are afraid for their jobs in many cases. Consumers are very, very cautious. We see that in their intentions to buy things. They're just not ready to part with money and probably with good reason.”

The recent pullback in the stock market and home prices that are still falling in many areas aren’t helping consumers feel more confident.

The housing market also faces a potentially tough summer following the expiration of a federal tax credit for home buyers. Applications for new mortgages fell sharply during the first week in June.

The pace of foreclosures remained at historically high levels last month, and bank repossessions set a new monthly record, according to RealtyTrac. As those repossessed homes are put back on to a distressed market, they’re likely to put further downward pressure on home prices.

It remains to be seen how much more stimulus spending the government can afford. In his testimony this week, Bernanke offered one of his sternest warnings to date on the need to pare the budget deficit and slow the growth of new national debt. But he cautioned against moving too quickly to cut spending before the economy is convincingly back on its feet.

Political pressure to balance spending and taxes will likely increase as lawmakers campaign in midterm elections. But the consequences of moving too quickly — and tipping the economy back into recession — could be dire, Zandi said.

“It’s a Japanese-like scenario,” he said. “If we go back into recession, we’ll get deflation and we’ll be trapped in the morass for a long time. We just can’t allow that.”