Does the U.S. Economy Need Another Fiscally Expensive Stimulus Package?

Source: REG Monitor

http://www.rgemonitor.com/

PrintThere have been large delays in implementing spending measures under the February 2009 stimulus package. The tax cuts have been implemented quickly but their impact on the consumption might be limited as consumers increase savings. As the economy is still weak and might recover at a sluggish pace and the unemployment rate is rising steadily, there are calls for a second stimulus package that is more front-loaded and targets the unemployed and cash crunched state governments. This comes at a time when estimates of trillion dollar fiscal deficits and unsustainable debt levels are raising inflation expectations and putting upward pressure on long-term yields, thus partly undoing Fed's monetary easing.

Calls for Another Fiscal Stimulus:
The administration hasn't endorsed a second stimulus package yet due to concerns about long-term fiscal sustainability. Passing another stimulus bill in the Congress will be very challenging. However, several people in the administration have said that the economic downturn has been worse than initially estimated, and the impact of the current stimulus might fade by 2011 pulling down GDP growth again if private demand is slow to recover.

June 2009: Obama announced to accelerate 10 projects under the stimulus package to boost economic recovery in Q3 2009 and create or save more than 600,000 jobs.
Obama signed the US$787 billion fiscal stimulus package in February 2009. The package at 5.4% of GDP included payroll tax cuts, other tax breaks for households, transfers for states, extension of unemployment benefits, tax credit for first-time home purchases, tax credits for firms to hire workers and invest in new equipment, and funds for Medicaid, infrastructure, education, construction, transport, broadband, energy, water and green agenda.

With the fading of stimulus effects and the expiry of the Bush tax cuts in 2011, the current policy would create a drag of around 2.5% of GDP in 2011. A US$250 billion stimulus package might be passed by late 2009/early 2010 that will be spread over 2010-2011 and reduce the drag on growth in 2011 by around half. The second stimulus might extend unemployment benefits and some tax reliefs including 'Making Work Pay' tax credit and provide extra support for states. (Goldman Sachs via Financial Times and the July 7 Report on 'Another Stimulus Package: Likely, But Not Imminent')

Another stimulus package might be passed in Q4 2009 when the unemployment rate is higher and will focus more on infrastructure rebuilding than on transfers. Another stimulus package of US$700 billion or 5% of nominal GDP might push the deficit above $2 trillion and the debt to GDP ratio to 70%. (BNP Paribas)

Brad DeLong: "The current stimulus is inadequate. Need Congress authority to guarantee the debt of states that seek to conduct their own state-level fiscal expansions. An additional US$500 billion of federal aid to states for FY2010 to be distributed per capita and conditioned on their maintaining effort at the provision of public services than cutting spending or raising taxes." (Wall Street Journal)
Bruce Bartlett: Implementation lags will prevent another stimulus package from impacting the economy anytime soon but will pose risk of inflation down the line.

Impact of the February 2009 Stimulus on the Economy:

The administration estimates that in the three months since the approval of the stimulus plan in February 2009, 11% of the funds have been given out creating 150,000 jobs. It expects stimulus to start boosting the economy in H2 2009. The government aims to spend 70% of the total US$787 billion by FY2010-end.
But contrary to administration's and Congressional Budget Office's estimates, some estimates suggest that as of May-end 2009, at the most US$40-45 billion of the stimulus had been spent. There has been a delay in allocation of funds from the federal to state/local governments and also to various departments, and also in the actual implementation of spending projects by these departments and state/local governments. Also decline in retail sales and consumer spending in April 2009 and small increase in retail sales in May 2009 imply limited impact of tax cuts on the thrifty households. Some estimates show that tax incentives for firms haven't been used fully. So most of the impact of stimulus might be eventually felt in H2 2009 compared to H1 2009 and more in 2010-11 compared to 2009. So the stimulus might temporarily boost growth in H2 2009, fading in early 2010. And it might boost growth without creating inflation in late-2010/early 2011 if private demand is slow to pick pick (though higher interest rate outcome may somewhat negate the effect).

Most of the impact on growth will be in Q2 (a little over 2% boost to GDP growth) and Q3 (2% boost to GDP growth) 2009 compared to Q1 (0.25% boost to GDP growth) and Q4 2009 (a little over 1% boost to GDP growth). Of the US$787 billion, at the most US$150 billion might be spent in 2009. But this will be inadequate to offset the contraction in private demand in H2 2009 so that GDP will continue to contract. This might also lead to a W-shaped impact on the economy in 2009 boosting growth in Q2 and Q3 with waning impact starting Q4 2009. So by early 2010 another stimulus package might be required. (RGE Monitor)

Extent of job creation will be limited as increase in private demand will be constrained by rising saving rate of households and domestic/global demand slump for firms. The stimulus might at the most prevent some job cuts including at the state/local government levels.

Also the stimulus will be inadequate to fill the state budget gap which is expected to run over $250 bn in FY2009-10. So state and local governments will continue to raise taxes and cut spending and cut jobs.

Stimulus might boost GDP growth by 1% in Q1 2009, close to 3% in Q2 2009, over 3% in Q3 2009 and close to 2% in Q4 2009, but the impact will fade later and become a drag on growth in H2 2010. (Goldman Sachs)

Around US90 billion of stimulus (US$60 billion in spending and US$30 billion in tax cuts) should be given out by Q2 2009. fiscal stimulus will add around 4% points to GDP growth in Q2 and Q3 2009 with the contribution quickly tapering off after that and turning negative in 2010. Discussion in Washington about speeding up the stimulus payout will further add to this year’s stimulus contribution. (JP Morgan)
As consumers spend only about one-quarter of tax cuts, tight credit limits multiplier effects of govt spending and alternate minimum taxation (AMT) extension provides little stimulus boost, less than 25% of the total stimulus impact will occur in FY2009. (Morgan Stanley)

Congressional Budget Office: Might raise GDP growth by 1.4-3.8% by Q4 2009 and 1.1-3.3% by Q4 2010. Might increase employment by 0.8-2.3 million by Q4 2009 and 1.2-3.6 million by Q4 2010. The positive effects of the stimulus will taper off dur­ing 2010 and subsequent years. Therefore, the recovery will falter in 2010 if private-sector demand for goods and services does not accelerate to offset the diminishing stimulus.

Romer and Bernstein: "Between Q1 2009 and Q4 2010, Obama's Plan will raise GDP growth by 3.7%, reduce unemployment rate by 1.8% and create around 3.3-4.1 million jobs."

Options for Stimulus Package:


Stimulus with highest bang-for-buck: Unemployment insurance, payroll tax relief, food stamps will alleviate impact on lower income groups (since they consume a larger share of their income) and help boost consumer demand.

Second best options: Infrastructure spending and aid for states have high multiplier effects but are not timely. Most of infrastructure investment (over 50%) and even renewable energy incentives will stimulate the economy only in 2010-11 with limited job creation since it is difficult to shift laid-off workers in manufacturing and services towards infrastructure. These measures should be a part of recovery package than anti-recession package. But ongoing construction activity, repair and maintenance might help since recession will last long. While Medicaid and other transfer to states and local governments will be stimulating, direct spending will help deficit-laden states to avoid cut back in public services and jobs amid recession, housing crisis and unemployment but may suffer time lags and may be used to pay off debt.

Least effective: Tax incentives are more timely and well targeted compared to infrastructure spending. But consumers might save close to 70% of the tax cuts (amid job losses, income and home/equity wealth has eroded significantly since the tax rebates were given in Q2 2008, saving rate will rise). Tax cuts for businesses will be less effective since firms forecasting prolonged slump in domestic/foreign demand in 2009, high credit cost will reduce business spending. Tax incentives for first-time home buyers inefficient since other factors (tighter credit, income/job losses) will continue to constrain home demand. Tax cuts will exacerbate the impact on fiscal deficit