Fiscal Stimulus Package Won't Avert the Recession

Includes: DIA, QQQ, SPY
by: John Makin

Excerpt from John Makin's latest commentary:

A stimulus package like the one under discussion in Washington can, like the measures in 2001 and 2002, be expected to provide at best a modest, temporary lift to growth, equal to a two-quarter rise in the annual GDP growth rate by about 1 percentage point. The actual impact of the current plan will probably be about half that for two reasons. First, the sharp one-third rise in energy prices during 2007 is the equivalent of an $80-$100 billion tax increase on U.S. households that will have boosted unpaid credit card balances. About one-half of a windfall tax increase will probably be used to pay down debt and therefore will not add to spending, although it will help to improve household balance sheets. Second, the rapid onset of recession and the associated wealth losses tied to falling stock prices and home values have increased uncertainty and reduced tolerance for risk by firms and households. These factors increase the likelihood that tax rebates will be saved, while investment incentives provide less stimulus to add to plant and equipment.

Coming as it does, somewhat late, after a sudden deterioration of household finances tied to the fallout from falling home prices and stocks, the stimulus package will not avert the recession that is already underway and--scaled at a nominal 1 percent of GDP of tax reductions--will not boost growth by enough to lift the economy out of negative growth during mid- to late-2008.

A collapsing housing bubble and the resulting financial damage tied to the leveraged securitization of claims whose value is highly sensitive to the path of real estate prices has intensified the cyclical pressures operating on the U.S. economy. A problem in the real economy tied to a sharp drop in house prices has caused substantial damage in the financial sector by reducing the value of widely dispersed real estate-based securities.

... We should see the fed funds rate at 2 percent by spring.