Stimulus Gets a Second Wind in Washington

There's probably nothing more politically radioactive right now than another fiscal stimulus package, considering that the first one will cost $787 billion and hasn't done much apparent good so far. Still, many economists say more fiscal stimulus is precisely what the U.S. economy needs to keep the recession from getting deeper and lasting longer.

At a speech in Singapore on July 7, Obama adviser Laura Tyson, stressing that she was expressing a personal opinion, said the package approved in February was "a bit too small," according to a Bloomberg news report. Tyson, who was President Bill Clinton's chief economic adviser, said: "The economy is worse than we forecast on which the stimulus program was based," according to Bloomberg. "We probably have already 2.5 million more job losses than anticipated."

The argument for more stimulus is simple: American consumers have abruptly switched from spending to saving in an effort to fix their sorry-looking household balance sheets. While that's healthy in the long run, in the short run it's disastrous for people who work for a living and need people to buy their goods and services.

A Collapse in Demand

In essence, there's a big shortfall of demand in the economy. Appetite from abroad is weak. The Federal Reserve has already cut short-term interest rates to virtually zero, so there's not much more that monetary policy can do. And state and local governments are required to balance their budgets, which means they have to match the shortfall in tax revenues with big spending cuts—which only worsens the spending decline. That leaves the federal government as the only entity capable of spending enough to prop up demand and protect jobs.BusinessWeek foreshadowed the emerging debate over a second stimulus package in a story published on Jan. 7, before the first one was even passed: "Fiscal conservatives in the U.S. worry about huge deficits, but one lesson from Japan is that halfway recovery measures lead to years of subpar growth that make deficits even bigger," the story said. "As big as it seems, Obama's stimulus is likely to be just a down payment."

The Obama Administration certainly isn't eager to push for another stimulus package, given the political unpopularity of the idea. Rasmussen Reports said on July 6 that 60% of U.S. voters oppose the passage of a second economic stimulus plan this year, up five percentage points from March. The share favoring a new plan was flat at 27%. And Senate Majority Leader Harry Reid (D-Nev.) dismissed the need for a second stimulus bill on Tuesday, telling Roll Call, "Just over 10 percent of the [original] stimulus money has been generated out. We're in the process of doing that." And on July 8, Robert Nabors, deputy director of the Office of Management and Budget, told Reuters, "No one in the administration is talking about a second stimulus at this point."

On the other hand, the Obama Administration may embrace further stimulus if it concludes this would help fight unemployment, which is even more politically toxic. The U.S. economy lost 467,000 jobs in June, and unemployment rose to 9.5%, the worst rate since 1983. The average workweek fell to 30 hours, the shortest since record keeping began in 1964.

Too Much, Too Late?

The U.S. could probably learn a thing or two from Japan, which has been mired in off-and-on recessions since the beginning of the early 1990s. Economists agree that one of Japan's critical mistakes came in early 1997, when the government allowed a tax rebate to expire and a scheduled increase in the national sales tax to go through. The shock to spending killed a nascent recovery. At other times, Japanese consumers didn't spend when taxes were cut because they knew taxes were going up again soon. Michael Smitka, an economist at Washington & Lee University's Williams School of Commerce, says that in spite of the inconsistency of fiscal stimulus in Japan, it probably prevented the nation's economy from doing even worse than it has.

The lesson from Japan for the U.S.? "We need fiscal stimulus, and we have to be careful to sell it as something that will continue until we are in a clearly self-sustaining recovery," says Smitka. To be sure, starting up a new stimulus package now runs the risk that it wouldn't start hitting until sometime next year. But help is needed right now. Kurl Karl, chief U.S. economist of Swiss Re, says: "I just don't see a lot of logic in it. It would aggravate all the concerns about the deficit. It could get interest rates going up and could harm the economy." Adds Karl: "If it really came in, it would probably be too much, too late."

A second stimulus will be too late if Karl is correct in his forecast that the economy will start to grow by the end of 2009. But if the recession drags on into 2010, more stimulus could be welcome even then. As for the short term, some economists favor quick tax cuts. The trouble with them is that consumers could end up saving rather than spending them, failing to stimulate the economy.

A surer way to provide help very quickly would be to increase federal assistance to the states. That would enable them to head off the draconian budget cuts they will be forced into this year and next. California is in such severe straits, with a projected budget deficit of more than $24 billion, that it has begun using IOUs to pay for state services. Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), and JPMorgan Chase (JPM), among other banks, said they would stop accepting the IOUs on July 10.

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