Economic Policy Will Have to Be Very Agile

It's easy to have too much of a temporarily good thing.

MARINA V.N. WHITMAN

Turning federal policy around on a dime is tricky. But it is what President Barack Obama and his economic team will have to know when and how to do.

The policies needed in the short term to avert further collapse of our financial system amid a global recession are the reverse of what is required in the long term to restore healthy growth in the United States. To balance the needs of the immediate against the demands of the future, the administration will have to focus on at least six tipping points:

- At the moment, the Fed's focus is rightly on avoiding price deflation. Deflation would push consumers to hold off on spending as they wait for lower prices down the road, prolonging the recession. Deflation would also increase the already heavy burden of debt carried by both the government and the private sector.

The threat of deflation is real. The Fed has worked aggressively to make sure money and credit are available. Yet the U.S. price level (a measure of overall prices) was almost certainly lower in 2008 than it was in 2007. If so, this will be the first such decline since 1955. The yields on TIPS (inflation-protected Treasury securities) are currently higher than on comparable securities without such protection, reflecting expectations of continuing price declines.

But once the world's economies are growing again, the Fed will have to contain the inflationary pressures it is now helping to generate. It will have to know when to step off the accelerator.

- The recent financial bailouts have helped prevent a near-total freeze in private lending. But in the long run, the government will have to mop up the liquidity those bailouts have provided by selling off the assets it is buying up. This sell-off will be difficult and contentious. It will be necessary, however, because the amount of liquidity central banks are now creating may turn out to be excessive and damaging to the world economy.

- Economic recovery can't begin until consumer spending picks up significantly -- as any retailer will testify. Yet to restore growth over the long term, Americans will need to increase their personal savings rate and not continue to rely on foreign loans to underwrite our economy. For years, the savings rate in the U.S. has hovered near zero.

- The contradiction between spending to grow the economy and saving to help stabilize economic growth is also something the government needs to reconcile. Added together, the Troubled Asset Relief Program and the proposed economic stimulus package account for about $1.5 trillion added to the government deficit. This is unsustainable and will eventually harm the national economy.

But halting stimulus projects once recovery is well underway will be politically difficult, if not impossible. Mr. Obama recognizes the challenge. He recently told the Washington Post that his administration will tackle entitlement reform and long-term budget deficits soon after it jump-starts job growth and the stock market.

- In the short run, we need to maintain low interest rates by financing federal spending with foreign money, mainly through purchases of U.S. Treasury securities, but also with, often controversial, private investments.

In the long term, this cannot last. Americans are right to be wary of relying on financing from China, Saudi Arabia and other countries. We can't count on them to have our national interests at heart and, in any case, they are starting to show a greater interest in investing in their own economies instead of ours, as we urged them to do.

- Finally, the steps needed to shore up the financial industry in the short run will probably have to be undone in the interest of long-term economic growth.

At the moment, large financial firms are being gobbled up by even larger financial firms. This consolidation has been welcomed and even actively encouraged by the government as an alternative to allowing a further weakening of the stability of our financial system. But the result will be a more consolidated financial services industry, which will both lessen competition and create more financial institutions that will be deemed too big to fail.

These outcomes threaten to make life more difficult for policy makers going forward, as they attempt to foster the creation of a more robust financial industry.

Mr. Obama and his economic team have an unenviable task. They have to have impeccable timing in reviving the economy and then, quickly, shift from the economic accelerator to the brakes in the months and years ahead. There are a lot of curves in the road that will put the new administration to the test.

Ms. Whitman is a professor of business administration and public policy at the University of Michigan and served on the Council of Economic Advisers under President Richard Nixon.