Top economist: Raise the debt ceiling or blow the recovery 'out of the water'

Mark Zandi, a prominent economic forecaster, says the US economy will gather steam in the second six months of 2011 – unless Congress fails to raise the government debt limit. In that case, “we go into recession, and my forecast would be blown out of the water,” he said Tuesday at a Monitor-hosted breakfast for reporters.

The chief economist of Moody’s Analytics, Dr. Zandi expects economic output to be growing at about a 4 percent rate by the end of 2011, versus 1.9 percent in the first three months of the year. “Weights on the economy are lifting,” he said, referring to diminishing effects of higher oil and food prices, as well as the impact of the Japanese tsunami on auto production.

Zandi remains wary of the return of high gas prices, he says, and thinks unemployment will fall slowly, but he remains cautiously optimistic about the overall economic recovery.

But Zandi's relatively upbeat outlook would change abruptly if Congress and the Obama administration fail to agree on a plan to raise the federal debt ceiling by August 2, requiring the government to dramatically curtail operations.

“If we get to August 2 and there is no debt ceiling limit, and there has to be significant spending cuts – even if Congress and the administration reverse themselves days later, I think the damage will have been serious, and we probably would be thrown into a recession,” Zandi said.

Why would even a short government shutdown have such a major impact? It's psychology, Zandi says.

“The collective psyche is extremely fragile, I think. As I talk to business people in every industry across the country, they are extraordinarily nervous. That’s why if anything goes slightly wrong, the negative consequences are amplified.”

Business executives are not the only ones whose confidence is shaky. The Conference Board, a business research group, said Wednesday that confidence among U.S. consumers unexpectedly fell in June to a seven-month low. One factor in declining consumer confidence: a tough job market. The percent of respondents expecting an increase in job availability fell to the lowest in 11 months, the business group said.

While confident about economic growth, Zandi said the jobless rate will be slow to decline, a which could pose a major problem for President Obama’s re-election prospects. He expects unemployment to close out 2011 at 9 percent.

“I do think that by next year, though, we will have enough job growth [to] more than absorb the folks coming into the labor force," he said. "Unemployment will fall. By year’s end 2012, I expect an unemployment rate that is closer to 8 percent.”

Failure to reach agreement on a debt ceiling increase is not the only major risk to the economy. “For my optimism to come to pass, a number of key assumptions have to hold,” Zandi said. “One is that $4 dollars for a gallon of regular unleaded was the peak for the year… If oil prices rise again, then I think my optimism would fade pretty fast. Nothing is worse for the economy than higher gasoline prices.”

Zandi is well regarded by both parties in Washington. He advised John McCain's presidential campaign and also has advised members of the Obama administration. The Wall Street Journal referred to him as "the de facto chief economist to Congress."