Resident Fellow  David Frum

Across the U.S., mortgages are being foreclosed. Banks are writing off bad loans. One investment bank has already failed, with who knows how many more to come. So is it a recession yet?

Oddly, the news from the overall American economy remains surprisingly better than expected.

On Friday, the U.S. government released a spate of important economic numbers.

They show consumer incomes continuing to rise, if very slowly. Consumer spending has flattened, but has not declined. Employers are adding new jobs only very slowly, but they are not yet cutting very severely, either.

In fact, new claims for unemployment insurance actually dropped slightly in the week ending March 28 as compared to the week before.

Nobody would describe the U.S. economy as booming. But it is not shrinking either, not according to the available numbers.

Yet, if the economic facts continue to be bearable, the American economic mood is blackening. Consumer confidence has plunged to the lowest level since the recession of 1992. Talk to financial professionals and you hear anxiety at best, outright panic at worst.

Here's what worries the pessimists: In 1992 and 2001, the Federal Reserve jolted the U.S. economy out of recession with big, bold cuts in interest rates.

But the Federal Reserve will not find it so easy to cut rates in 2008. The dollar is already anemically weak: More rate cuts could send the U.S. currency tumbling--and a lower dollar will in turn lead to higher prices for energy, food, metals and imported products generally. For the first time since the 1970s, Americans are confronting the risk of stagflation. In a stagflating economy, interest rate cuts yield higher prices, not stronger growth.

Fearing stagflation, the Fed may not dare to cut rates further. What then?

Then the U.S. government might try cutting taxes or raising spending--"fiscal stimulus" as the economists call it. There's just one problem: Fiscal stimulus does not usually work very well. It arrives too late, or it costs too much relative to the good it does, or consumers (rationally) use it to repay debt rather than to boost their consumption.

Congress has already voted for just such a plan: $168-billion in tax rebates that will arrive sometime in the second half of 2008--too late to help with today's crisis, and just in time to add to a swelling federal budget deficit next year.

Meanwhile, the Democratic candidates for president are spending their days frightening markets with reckless talk. Hillary Clinton has proposed a federal freeze in mortgage interest rates, a moratorium on foreclosures of houses that do not pay their debts and a large federal bailout of mortgage lenders. Barack Obama's plan is marginally less irresponsible--but that greater prudence probably reflects Obama's lead in the Democratic delegate count rather than any better economic sense.

And yet some good may come of this crisis, if it wakes American voters up to this all-important political fact: Today's Democratic Party is no longer the Democratic Party of Bob Rubin, no longer a party of careful economic management and middle-of-the-road practical sense.

Obama and Clinton are competing to sound more protectionist, more interventionist, more regulatory, more reckless. Perhaps they personally know better. That's the message Barack Obama aide Austan Goolsbee whispered to the Canadian consul-general in Chicago, and it may even be true.

But what politicians publicly say matters as much as what they privately think. Promiscuous pandering promises harden into inescapable commitments. A politician like Hillary Clinton or Barack Obama may seek only to exploit a financial crisis. They end by stoking it.

John McCain's challenge and opportunity is to rise above this kind of crass self-seeking, and to articulate a financial and economic message that can actually do some good--beginning by refraining from doing harm.

David Frum is a resident fellow at AEI.