Rethink the Stimulus Package

There's good news and bad news on the interest-rate front. Thanks to quick action by the Federal Reserve, short-term rates have dropped a dramatic 425 basis points since March, 2000, buoying the housing and auto markets through the downturn and setting the stage for recovery. Long-term rates, however, have recently reversed course and backed up sharply, threatening that rally. Anyone shopping for mortgages in the past few weeks knows that rates are up to 7% again. Not good.

There are a number of reasons for this long-term rate hiccup. At the end of the recessions of 1975, '83, and '91, long-term rates also increased, albeit temporarily, as inflation worries returned to grip investors. This may be occurring right now as the economy bottoms out. But something else may be at work, too: the shift of the federal budget from surplus to deficit until at least 2005. The financial markets have been expecting surpluses as far as the eye could see to pay for backloaded tax cuts over the next decade. With unexpected military and home-defense spending beginning to soar, worries over deficit spending and rising inflation in the years ahead are resurfacing, pushing up long-term rates. It's fine for the budget to run red when the economy is in recession. That puts more money into consumers' hands and pumps up demand. But the economy should be on the mend by late 2002, if not earlier. Deficits that extend any longer will hurt, not help, growth.

It may be wise to take a moment to regain control over fiscal policy in Washington. That means tempering the stimulus package now being debated in Congress--or perhaps even postponing it entirely. Congress has already taken far too long in passing it for it to have any real economic impact on the recovery. Moreover, the package itself is a hodgepodge of pork barrel spending and tax cut proposals designed more to placate political constituencies than to address the needs of the overall economy.

If the politicians insist on passing a bill before the Christmas holiday, they should trim it down to three items: cutting depreciation rates for just one year, to encourage companies to buy new equipment; extending unemployment benefits for a few more weeks; and accelerating a marginal tax rate cut for just one bracket, lowering the 27% bracket to 25%. Everything else should be stripped out. It's time to think about getting the budget back into balance.

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