The Stimulus Package: The Good, the Bad and the Ugly
THE FOLLOWING COMMENTARY WAS DELIVERED OVER WAMC RADIO BY MICHAEL MEEROPOL ON FEBRUARY 1, 2008
On January 29, the House of Representatives passed, a bill called a "stimulus package." 1
According to the politicians, the bill is designed to provide an increase in spending soon so as to either head off a recession or (more likely) help counteract a recession that has already begun. 2Perhaps the most significant thing about this action is a question that too few people have asked - What took them so long?
Politicians, economists and pundits spent last year first denying that the housing bubble was exploding and then claiming that the problem was basically confined to the sub-prime lending market. 3
At the November meeting of the FOMC, the chief policy-making body of the FED, they were still talking about the danger of inflation. 4
But on January 22, they took the extraordinary step of cutting their major policy interest rate by three-quarters of a percent, thereby telegraphing their panic over the dangers of recession. 5
In the wake of stock market gyrations all around the world, the Fed's panic, and the continued free fall in the housing market which has had a very negative impact on consumer confidence, President Bush and Congress are under extreme pressure to "do something." The something they are doing is very little, very late, and focused in part on the wrong people.
First the numbers - The total decrease in Federal tax revenue associated with this package is $146 billion. 6 This is the good part because it will increase total income. Though not insignificant, (it is a bit over 1% of GDP) the change in the fiscal posture of the US government is much smaller than the fiscal stimulus created in 1975 when the economy was battling a deep, painful recession. 7
But unfortunately, the bad part of the package is that a lot of the tax relief will go to individuals and families with relatively high incomes. Families making between $100,000 and $150,000 will get a $1200 rebate. Individuals making that much will get $600. It is unlikely that much of that will be spent immediately. Short term windfalls will not change consumption patterns for well-off people. That is why the director of the Congressional Budget Office told members of Congress that the best way to get money into the hands of citizens most likely to spend all of it immediately would be to extend unemployment benefits and increase the availability of food stamps. 8
The failure to increase unemployment insurance is the worst thing about this bill - the truly ugly part. When people become unemployed, they strive to maintain their previous levels of consumption. Thus, virtually all of their unemployment checks get spent on current consumption items. Extending benefits from 26 weeks to 39 weeks or even longer will permit those laid off workers to keep their consumption spending up.
One of the great values of increasing food stamp availability is that unlike the tax cuts and rebates that will put cash in the hands of consumers - cash that might be spent on imported goods - food stamps can only be spent on food, most of which is produced domestically.
Because the politicians waited so long to act, we are now being told they must rush this compromise through in order to get the rebate checks into people's hands by May or June. Thus, there is tremendous pressure on the Senate not to attempt to amend this bill. I urge you to tell your Senators to resist this pressure. Extending unemployment benefits and expanding food stamp availability will not only be the right thing to do - it will make the bill a more effective stimulus.
Footnotes:
1 See "$146 Billion Stimulus Plan Passes House" Washington Post January 30, 2008; Page A03 http://www.washingtonpost.com/wp-dyn/content/article/2008/01/29/AR2008012901935.html?hpid=topnews
2On January 31, the New York Times reported that the GDP had grown at a disappointing .6% during the fourth quarter of 2007 suggesting that by the end of the year growth might have turned negative thus heralding the start of a recession. Recessions are "called" by the National Bureau of Economic Research many months after they have begun so we will not know for sure for some time. However, with growth slowing to a dead stop, declines in housing sales and prices, rises in unemployment, slowdowns in job creation, huge write-downs by financial institutions there is every indication that a recession is here or almost here. See my most recent commentary.
3 See, for example, the following article in the New York Times in October of 2007. Note that this was already into the last quarter - the quarter that now we find saw growth plummet to .6% after posting a 4.9% rate of growth in the third quarter (see http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.). The New York Times piece described job growth in September as having "bounced back" which combined with a revision in the numbers for August were, "…easing fears of a recession and making it more likely the Federal Reserve will hold interest rates steady when it meets at the end of this month [September]. The news set off a surge on Wall Street, sending the Standard & Poor's 500-stock index to a record close. The economy added 110,000 jobs in September, and the Labor Department reported that employment increased by 89,000 jobs in August, revising an earlier report that showed an unexpected loss of 4,000 jobs. The original figure prompted a stock market sell-off and was followed by a half-point cut in the Fed's benchmark interest rates as investors worried that turmoil in the housing market had bled into the larger economy. Today's report - considered a leading indicator of the nation's economic health - suggests that pain from the subprime lending crisis subsided somewhat in September. Government and education jobs rose sharply, spurring the upward revision for August." http://www.nytimes.com/2007/10/05/business/04cnd-econ.html?emc=eta1 Read that ridiculously optimistic last sentence again!
4 It is sometimes instructive to read the minutes of the Federal Open Market Committee. At the meeting October 30-31 (the commentary called it the November meeting because the results were announced November 1) there were references to the "upside risks to the outlook for inflation" [p. 7] and the following statement as well: "Readings on core inflation had improved modestly during the year, but the Committee judged that some inflation risks remained, and the Committee planned to continue to monitor inflation developments carefully." [p. 4] For the full minutes see http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20071031.pdf 5 Because the level of total (aggregate) demand helps determine both the inflation rate and the unemployment rate - but has the opposite effect of both - it is impossible to use the tool of aggregate demand management (fiscal and monetary policy tools) to fight both problems at the same time. Thus, policy-makers basically have to choose which problem - inflation or unemployment - is likely to pose the most immediate danger. It is clear that between the end of October and January 22, the Fed changed its main focus from fearing inflation to fearing recession.
6 This refers to the House bill passed on January 29. There will no doubt be many changes in the bill before it reaches the President's desk.
7 In March of 1975, Congress pass a significant tax cut at the urging of (Republican) President Gerald Ford. That tax cut was clearly focused on increasing consumption. Marginal rates were not cut, and instead all taxpayers and their dependents received a credit of $30 (over $100 in current dollars). In addition, the standard deduction was increased, and a refundable earned income tax credit was enacted. As a result, some beneficiaries of the 1975 tax cut carried no liability for federal individual income taxes. Here's where the fiscal stimulus difference becomes apparent. The federal budget was nearly balanced in 1974, with a deficit of less than 1% of GDP. That deficit, however, jumped to 3.4% of GDP in fiscal year 1975 and 4.3% in the following year. (See Economic Report of the President, 1998, p. 373.) It is clear that the 1975 tax cut, plus some increased spending in the form of extended unemployment compensation benefits, helped raise the federal deficit and increase aggregate demand. As a consequence, this deficit increase was temporary; both deficits and debt as a share of GDP fell at the close of the 1970s.
8 For the testimony of Peter Orszag, Director of the Congressional Budget Office, see http://www.cbo.gov/ftpdocs/89xx/doc8932/1-22-TestimonyEconStimulus.htm Director Orszag noted that "… tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power. The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments. But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers
On January 29, the House of Representatives passed, a bill called a "stimulus package." 1
According to the politicians, the bill is designed to provide an increase in spending soon so as to either head off a recession or (more likely) help counteract a recession that has already begun. 2Perhaps the most significant thing about this action is a question that too few people have asked - What took them so long?
Politicians, economists and pundits spent last year first denying that the housing bubble was exploding and then claiming that the problem was basically confined to the sub-prime lending market. 3
At the November meeting of the FOMC, the chief policy-making body of the FED, they were still talking about the danger of inflation. 4
But on January 22, they took the extraordinary step of cutting their major policy interest rate by three-quarters of a percent, thereby telegraphing their panic over the dangers of recession. 5
In the wake of stock market gyrations all around the world, the Fed's panic, and the continued free fall in the housing market which has had a very negative impact on consumer confidence, President Bush and Congress are under extreme pressure to "do something." The something they are doing is very little, very late, and focused in part on the wrong people.
First the numbers - The total decrease in Federal tax revenue associated with this package is $146 billion. 6 This is the good part because it will increase total income. Though not insignificant, (it is a bit over 1% of GDP) the change in the fiscal posture of the US government is much smaller than the fiscal stimulus created in 1975 when the economy was battling a deep, painful recession. 7
But unfortunately, the bad part of the package is that a lot of the tax relief will go to individuals and families with relatively high incomes. Families making between $100,000 and $150,000 will get a $1200 rebate. Individuals making that much will get $600. It is unlikely that much of that will be spent immediately. Short term windfalls will not change consumption patterns for well-off people. That is why the director of the Congressional Budget Office told members of Congress that the best way to get money into the hands of citizens most likely to spend all of it immediately would be to extend unemployment benefits and increase the availability of food stamps. 8
The failure to increase unemployment insurance is the worst thing about this bill - the truly ugly part. When people become unemployed, they strive to maintain their previous levels of consumption. Thus, virtually all of their unemployment checks get spent on current consumption items. Extending benefits from 26 weeks to 39 weeks or even longer will permit those laid off workers to keep their consumption spending up.
One of the great values of increasing food stamp availability is that unlike the tax cuts and rebates that will put cash in the hands of consumers - cash that might be spent on imported goods - food stamps can only be spent on food, most of which is produced domestically.
Because the politicians waited so long to act, we are now being told they must rush this compromise through in order to get the rebate checks into people's hands by May or June. Thus, there is tremendous pressure on the Senate not to attempt to amend this bill. I urge you to tell your Senators to resist this pressure. Extending unemployment benefits and expanding food stamp availability will not only be the right thing to do - it will make the bill a more effective stimulus.
Footnotes:
1 See "$146 Billion Stimulus Plan Passes House" Washington Post January 30, 2008; Page A03 http://www.washingtonpost.com/wp-dyn/content/article/2008/01/29/AR2008012901935.html?hpid=topnews
2On January 31, the New York Times reported that the GDP had grown at a disappointing .6% during the fourth quarter of 2007 suggesting that by the end of the year growth might have turned negative thus heralding the start of a recession. Recessions are "called" by the National Bureau of Economic Research many months after they have begun so we will not know for sure for some time. However, with growth slowing to a dead stop, declines in housing sales and prices, rises in unemployment, slowdowns in job creation, huge write-downs by financial institutions there is every indication that a recession is here or almost here. See my most recent commentary.
3 See, for example, the following article in the New York Times in October of 2007. Note that this was already into the last quarter - the quarter that now we find saw growth plummet to .6% after posting a 4.9% rate of growth in the third quarter (see http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm.). The New York Times piece described job growth in September as having "bounced back" which combined with a revision in the numbers for August were, "…easing fears of a recession and making it more likely the Federal Reserve will hold interest rates steady when it meets at the end of this month [September]. The news set off a surge on Wall Street, sending the Standard & Poor's 500-stock index to a record close. The economy added 110,000 jobs in September, and the Labor Department reported that employment increased by 89,000 jobs in August, revising an earlier report that showed an unexpected loss of 4,000 jobs. The original figure prompted a stock market sell-off and was followed by a half-point cut in the Fed's benchmark interest rates as investors worried that turmoil in the housing market had bled into the larger economy. Today's report - considered a leading indicator of the nation's economic health - suggests that pain from the subprime lending crisis subsided somewhat in September. Government and education jobs rose sharply, spurring the upward revision for August." http://www.nytimes.com/2007/10/05/business/04cnd-econ.html?emc=eta1 Read that ridiculously optimistic last sentence again!
4 It is sometimes instructive to read the minutes of the Federal Open Market Committee. At the meeting October 30-31 (the commentary called it the November meeting because the results were announced November 1) there were references to the "upside risks to the outlook for inflation" [p. 7] and the following statement as well: "Readings on core inflation had improved modestly during the year, but the Committee judged that some inflation risks remained, and the Committee planned to continue to monitor inflation developments carefully." [p. 4] For the full minutes see http://www.federalreserve.gov/monetarypolicy/files/fomcminutes20071031.pdf 5 Because the level of total (aggregate) demand helps determine both the inflation rate and the unemployment rate - but has the opposite effect of both - it is impossible to use the tool of aggregate demand management (fiscal and monetary policy tools) to fight both problems at the same time. Thus, policy-makers basically have to choose which problem - inflation or unemployment - is likely to pose the most immediate danger. It is clear that between the end of October and January 22, the Fed changed its main focus from fearing inflation to fearing recession.
6 This refers to the House bill passed on January 29. There will no doubt be many changes in the bill before it reaches the President's desk.
7 In March of 1975, Congress pass a significant tax cut at the urging of (Republican) President Gerald Ford. That tax cut was clearly focused on increasing consumption. Marginal rates were not cut, and instead all taxpayers and their dependents received a credit of $30 (over $100 in current dollars). In addition, the standard deduction was increased, and a refundable earned income tax credit was enacted. As a result, some beneficiaries of the 1975 tax cut carried no liability for federal individual income taxes. Here's where the fiscal stimulus difference becomes apparent. The federal budget was nearly balanced in 1974, with a deficit of less than 1% of GDP. That deficit, however, jumped to 3.4% of GDP in fiscal year 1975 and 4.3% in the following year. (See Economic Report of the President, 1998, p. 373.) It is clear that the 1975 tax cut, plus some increased spending in the form of extended unemployment compensation benefits, helped raise the federal deficit and increase aggregate demand. As a consequence, this deficit increase was temporary; both deficits and debt as a share of GDP fell at the close of the 1970s.
8 For the testimony of Peter Orszag, Director of the Congressional Budget Office, see http://www.cbo.gov/ftpdocs/89xx/doc8932/1-22-TestimonyEconStimulus.htm Director Orszag noted that "… tax cuts or increases in transfer payments from the government to people (such as Food Stamps or unemployment insurance benefits) increase household demand by providing consumers with additional spending power. The bigger the chunk of that additional income that consumers are willing to spend instead of save, the more stimulus there will be from a particular tax reduction or increase in government transfer payments. But households do not predictably spend a fixed proportion of the extra income left in their hands when taxes are reduced or transfers
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