Stimulus Needed to Restore Confidence, Economists Say

MBA (1/11/2008 ) Palaparty, Vijay
The effectiveness of a fiscal stimulus to keep the current weak U.S. economy afloat depends on how timely, targeted and how long it is administered, according to panelists speaking yesterday at The Brookings Institution. The stimulus could ultimately have potential to restore needed confidence in the American public.
“The economy is slow but our forecasts do not lean toward a recession,” said Doug Duncan, chief economist and senior vice president of research and business development at the Mortgage Bankers Association. “The chances of a recession, though, are about 50/50. Quarter-over-quarter, there is negative employment growth in the private sector and that is a warning sign. Housing is central to the slowdown and any stimulus package that addresses the housing sector would certainly help curb the downturn.”

“A fiscal stimulus must be timely because the average recession does not last long and providing stimulus after stimulus could push up inflation. If it is delayed, it will not have a positive effect,” said Douglas Elmendorf, senior fellow at The Brookings Institution, author of a briefing paper, If, When, How: A Primer on Fiscal Stimulus. “It is complicated to predict because forecasting economic conditions is difficult and the political process in implementing a stimulus also takes time. Also, affecting both household and business spending behavior requires time. Helping the economy requires policy that can be administered quickly to stimulate the economy.”

Panelists predicted the likelihood of a recession at 50 percent. Troubles in the housing market, escalating oil prices, problems in credit markets and the weakening U.S. dollar paint a bleak picture—conditions that have historically led to recession.

“A combination of factors relating to oil prices and federal fund interest rates have been followed by an economic downturn in history,” said Martin Feldstein, director of the Hamilton Project and professor at Harvard University. “This time it is more than just that. The reasons to worry about the likelihood of a recession are because of the collapse in housing construction and fall of house values and prices—both of which have cut into household wealth and consumer spending. The most difficult to quantify is the changes in financial markets. It’s not just a shortage of liquidity and lack of confidence among financial institutions—they lack confidence in themselves and each other.”

Alternatives proposed in response to the threat of recession include offering personal tax credits, expanding programs such as unemployment insurance and food stamps to those facing extreme economic difficulty and further cutting Federal Reserve interest rates. Some even sugested a payroll tax holiday. Regardless, all agreed that the fiscal size of the stimulus would require at least $100 billion.

A targeted stimulus can maximize potential of helping those most hurt by the economic downturn while also growing the GDP, Elmendorf said. “Programs such as personal tax credits can be implemented quickly and channel to households that spend a good share of what they receive—especially to households that do not have a positive tax situation, providing stimulus when they most need it.”

“The Federal Reserve should cut interest rates but simply lowering the rate may not be enough to bring strength to the economy. Supplementing the economy with money, with a purpose to create jobs and increase GDP, is important. It is about how to get the economy to avoid recession or to have a mild one if it occurs. Policymakers should propose a conditional fiscal stimulus and pass legislation on a specific cut in taxes.” Feldstein said.

Mark Zandi, chief economist at Moody’s Economy.com, disagreed with Feldstein, saying that a focus on employment as a trigger for fiscal stimulus would be ineffective. “Using unemployment as a trigger is a mistake—it’s a bad measure that could overstate growth significantly, and it can be revised. The difference between a soft economy and recession is confidence. It’s vital that we move forward aggressively.”

Implementing the stimulus in the early stages of a potential recession—at the beginning of an economic downturn—is important. Additionally, a stimulus package could rebuild and restore confidence in the American public—to ease their worries over finances and job loss.

The length of a fiscal stimulus program also affects its potential. Long-term stimulus and policy changes do not have the same effect as short-term ones, Elmendorf said. “The federal budget is out of balance and would be terribly out of balance with a long-term fiscal stimulus. Tax cuts and stimulus can promote spending when the economy needs it. Long-term proposals can also do this, however the expectation of higher future budget deficits could push interest rates up."

Containing current weak areas in the economy could also be an alternative to keeping current conditions in control. For example, providing means for the housing market to regain some kind of footing requires assistance.

“The chances of not getting into a recession depend on containing it. The declining housing crisis and foreclosure problem grew out of subprime but we know that it is not only limited to subprime. There is nothing we can do about the housing surplus or those who over-borrowed. But lenders and community organizations, along with some levels of government, can work together to keep families in their homes and when foreclosures do occur, there should be an orderly transition to get a family back in the house. That is a harder kind of policy than designing a fiscal stimulus,” said Alice Rivlin, senior fellow at The Brookings Institution and former vice chairman of the Federal Reserve. “Everyone should work very hard on containing these specific problems.”

“The question of uncertainty and balancing risk is difficult considering the tremendous amount of political and economic uncertainties,” said Jason Furman, senior fellow at The Brookings Institution and co-author of the report. “Fiscal policy takes a lot of time to implement change and the current economy is unclear. The goal of the stimulus is about helping the economy as a whole—to protect families from risk.”
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