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Assessing The Impact of The Fiscal Stimulus
Assessing The Impact of The Fiscal Stimulus
Assessing The Impact of The Fiscal Stimulus
Economic Impact of
Fiscal Stimulus 2008
by
Mark M. Zandi
T
he president and Congress are the risks of recession and the need for Arizona, California, Florida, Michigan
quickly coalescing around a fiscal stimulus. The economy is indeed and Nevada. These states account for a
fiscal stimulus plan to shore struggling. Real GDP likely grew near 1% fourth of national GDP. Alaska, Arkansas,
up the flagging economy. As currently in the fourth quarter of 2007, and the Connecticut, Minnesota, Missouri, Ohio,
envisioned, the plan is expected to cost economy appears to be contracting in Rhode Island, Vermont and Virginia
at least $150 billion and include a sizable early 2008. The job market has stalled, are on the edge of recession. These
tax rebate, short-term tax incentives for Christmas sales were soft, and industrial states account for an additional 15%
business investment, and temporary production has gone flat. of national GDP. The large metro area
increases in unemployment insurance The threat of recession is evident economies of the Northeast from Boston
benefits and food stamps. This stimulus in the recent substantial increase in to Washington, D.C. are still expanding,
will not prevent a recession if one is unemployment. The jobless rate has but growth is slowing sharply, particularly
already on its way, as its benefits will not risen 0.6 percentage points from its around New York City, which is being
be realized until summer; however, it 4.4% cyclical low last March to 5% hurt by Wall Street’s travails. If these
could substantially mitigate the severity in December. Recessions are always economies begin to contract, a national
of any downturn. Under reasonable preceded by such a rise, and one has recession will have begun (see Chart 2).
assumptions, the stimulus will add 1½ never occurred without a recession The need for fiscal stimulus is
percentage points to annualized real ensuing (see Chart 1). Unemployment is reinforced by the possibility that
GDP growth during the second half of typically the catalyst for a recession spiral monetary policy has become less
2008. Employment will grow by an extra because increased joblessness undermines
700,000 jobs, and the unemployment rate consumer confidence and thus consumer
will be as much as a half percentage point spending. Businesses respond to flagging
Regional economies are determined by Moody’s Economy.
lower by mid-2009 than would be the sales by cutting back investment and com to be in recession using a methodology similar to that
case without Washington's help. payrolls, and unemployment rises further. developed by the National Bureau of Economic Research
for gauging national recessions. Payroll employment and
Why stimulus? With a presidential A negative, self-reinforcing cycle begins. industrial production are the two principal indicators of
election fast approaching, policymakers A number of large state economies persistent, broad-based decline in economic activity. A list of
metro areas in or near recession is available on request.
have come to a quick consensus regarding are likely already in recession, including
Chart 1: Rising Unemployment Signal Recession Chart 2: State Economies in or Near Recession
Year-over-year % change in unemployment
80
Source: BLS
70
60
50
40
30
20
10
0
-10
-20 In recession
Near recession
-30 Expansion
69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
3.75
600
3.50
400 3.25
3.00
200
2.75
Source: CBOT
2.50
0
01 02 03 04 05 06 07H1 07H2 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08
effective in stimulating growth. The most and implemented through the political season—a time when refiners’ operating
immediate conduit between monetary process, making it difficult to put together margins rise with consumer demand. If
policy and the economy runs through a plan quickly enough to support a refiners’ margins return to their long-
the housing market. Housing is the struggling economy. Historically, the run historical norms, a gallon of regular
most interest rate-sensitive sector of the action often took effect well after the unleaded gasoline will sell for $4, up from
economy, and historically it would receive economy had recovered, making such just over $3 currently. Since every 1-cent
a quick boost from monetary easing. stimulus counterproductive. per gallon increase in gasoline prices costs
This boost will be much more muted This criticism should be at least consumers more than $1 billion annually,
today given the ongoing problems in the partially stilled by the relatively rapid Americans’ driving bills are set to increase by
mortgage securities market. Issuance of response of policymakers during and after $100 billion. That acts very much like a tax
bonds backed by subprime, alternative-A, the 2001 recession. Washington enacted increase; if households must spend more to
and jumbo mortgage loans has collapsed a tax rebate, extended unemployment drive, they have less to spend on everything
(see Chart 3). Save for conforming fixed- insurance benefits beyond the usual 26 else. The impact is even more pernicious
rate loans, which are only loosely tied weeks, accelerated depreciation for new than a tax increase, since tax proceeds
to Fed actions, lenders are unable and business investment, and imposed other typically finance government spending,
unwilling to extend mortgage credit at any smaller tax cuts and benefits. The cost whereas much of what is spent on gasoline
interest rate. was approximately $100 billion, equal goes to overseas energy producers.
The Federal Reserve may also to about 1% of GDP. While subject to The $150 billion stimulus plan can
be constrained in its response to the much debate then and afterward, this also be thought of as making up for the
economy’s problems because of concerns stimulus likely mitigated the severity of difference between current consensus
with inflation, which remains elevated that downturn. expectations this year and the economy’s
despite the weak economy. Commodity How big a plan? President Bush’s potential growth. While economists have
prices are at record levels, the exchange currently proposed fiscal stimulus plan quickly marked down their forecasts,
value of the U.S. dollar is falling, import is a comparable 1% of GDP, equal to just according to the Blue Chip survey the
prices are up and labor productivity under $150 billion. This is big enough consensus is for real GDP to advance
has slowed. Financial markets have to to provide a meaningful economic boost. less than 2% this year. Most economists
date been disappointed with the Federal Assuming the $150 billion is distributed have not assumed the passage of a fiscal
Reserve’s reticent response to events. this summer, and that just half is actually stimulus plan, and most put potential
Investors may be even more disappointed spent by year’s end, it would add well over growth at below 3%. If economists are
in coming weeks as they are pricing in a a percentage point to annualized real GDP correct about growth this year, then a
near 2% federal funds rate target by late growth during the second half of 2008. $150 billion stimulus plan would simply
this year, down from 3.5% currently (see How big a boost, of course, depends on put the economy back closer to its trend.
Chart 4). Well-timed and temporary fiscal the details of the stimulus plan. If economists are wrong, it is likely they
stimulus could jump-start growth and Another way to gauge the magnitude will have erred on the side of optimism,
give monetary authorities more latitude to and importance of the $150 billion and the economy is already in recession.
focus on longer-term inflation objectives. stimulus package is to consider the In that case fiscal stimulus would be
The use of fiscal policy to support looming potential increase in the cost of especially helpful.
a flagging economy has also regained gasoline this spring. If oil prices remain Tax rebate. The goal of a fiscal
credibility given its successful deployment near their current $90 per barrel, gasoline stimulus plan is to maximize the near-
in 2001. A valid criticism of fiscal prices will increase sharply once refiners term boost to economic growth without
stimulus is that it must be fashioned begin gearing up for this summer’s driving weakening the economy’s longer-term
0.65 400
0.75
0.53 300
0.50
200
0.25 100
0.00 0
2nd half of 08 First half of 09 Dec-08 Jun-09
helping states today would encourage to know just when the projects will get to the economy during the second half of
more profligacy in the future also appear under way and the money spent. Also this year and early in 2009. Neither plan
overdone. Apportioning federal aid to complicating the use of infrastructure will prevent a recession if one has already
states based on their size (either by spending is the politics of apportioning begun, because they will not benefit the
GDP or population), rather than on the these funds across the country in economy until midyear at best. Yet they are
size of their budget shortfalls, would a logical and efficient way. Simply substantive enough to significantly mitigate
substantially mitigate this concern. allocating the funds proportionately the severity and length of any downturn.
Other options. Fiscal policymakers could very well result in some poorly Taking the president’s lead,
have a number of other options for designed projects being funded. Congress is most likely to pass a fiscal
providing stimulus, some of which have Making the current dividend income stimulus plan costing $150 billion. The
been used in the past, but have some and capital gains tax rates permanent plan will include a non-refundable $100
significant shortcomings and are thus not would also make for poor economic billion tax rebate; bonus depreciation
likely to be included as part of the current stimulus. The current 15% tax rate and increased expensing for small
stimulus plan. Most notable are spending that most investors currently pay is set businesses costing $25 billion; and
on the nation’s infrastructure and making to soon expire and tax rates will jump. an extension of UI benefits and an
the current tax rates on dividend income There is an argument that making them expansion of food stamps that together
and capital gains permanent. permanent would create some certainty account for the remaining $25 billion.
On the face of it, increased for investors who are currently very We assume the plan becomes law in
infrastructure spending appears to be a uncertain regarding the prospects for the March, and the tax rebate is issued
particularly efficacious way to stimulate stock and bond markets. Regardless of between mid-June and mid-August. The
the economy. The boost to GDP from a the longer-term benefits of taking such investment incentives and the expanded
dollar spent on building new bridges and a policy step, however, the near-term UI and food stamp benefits are assumed
schools is estimated to be a large $1.59, economic boost would be small. The to extend through mid-2009.
and who could argue with the need problems plaguing financial markets This plan will lift annualized real
for such infrastructure. The overriding are broad and deep and unlikely to be GDP growth by 1.5 percentage points
limitation of such spending as a part measurably affected by such a policy during the second half of 2008, and
of a stimulus plan, however, is that it change. Moreover, even under the best by 0.5 percentage points during the
generally takes a substantial amount of circumstances in financial markets, first half of 2009. (see Chart 6). The
of time for funds to flow to builders the impact of such a move has a small additional output growth translates into
and contractors and into the broader estimated economic bang-for-the-buck of nearly 450,000 more jobs by year-end
economy (see Table 1). It should be only $.37. 2008 than would be created without
noted that the economic bang for the buck Macroeconomic impacts. To assess the stimulus, and 700,000 more
estimates shown in Table 1 measure the the macroeconomic consequences of jobs by midyear 2009 (see Chart 7).
change in GDP one year after the spending fiscal stimulus, Moody’s Economy.com Unemployment will be measurably lower
actually occurs; it says nothing about how simulated two different hypothetical as a result, with the jobless rate nearly
long it may take to cut a check to a builder plans. The first plan is the most likely half a percentage point lower by mid-
for a new school. Many infrastructure to become law given current political 2009 (see Chart 8).
projects can take years from planning to realities, while the second is an idealized
completion. Even if the funds are only plan whose objective is maximizing near-
used to finance projects that are well term economic growth, without regard to
Monetary policy as measured by the federal funds rate is
along in their planning, it is very difficult politics. Both provide a measurable boost determined endogenously in the model based on a Taylor-
rule reaction function.
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