The second stimulus and the US economy
AS the world economy struggles to recover from the current global recession, the focus now in the US is shifting to a new and politically charged question, "Do we need a second stimulus?" The arguments for and against a second stimulus package are both very strong, and often very convincing. The debate is also taking place in the context of a compelling time frame -- the mid-term elections in November 2010 -- which could very well be decided on whether the US economy has bounced back from two years of insipid performance, and whether the unemployment rate has turned around to go back into the single digit fold. The Democrats have reasons to be nervous that their war cry during the 1990's, which catapulted Bill Clinton into the presidency, "It's the economy, stupid," might now fall into the wrong hands
It is by now accepted by almost all involved in public policy debates in the US that President Obama's first stimulus package, in the form of American Recovery and Reinvestment Act of 2009 (ARRA), has shown lukewarm to modest results. Banks and other financial institutions are strong again, foreclosures are down, the precipitous decline in housing prices has been stabilised, and mortgage delinquencies are no longer out of control. There are signs of "green shoots," the first signs of spring, and regeneration in the bleak landscape that Obama inherited in January of this year.
The large auto companies have also successfully undergone major restructuring, and supporting policies, including low interest auto loans and innovative programs like "Cash for Clunkers" which allowed car buyers to trade in old gas guzzlers for new fuel efficient cars for a $4,500 tax credit, have kept drivers coming to the showrooms.
While there is still some weakness in segments of the housing market, particularly in Nevada, California, and Florida, the inventory of unsold homes has steadily declined and so has the average time a house is on the market. This trend has been helped by the first-time homebuyers' $8,000 tax credit and low mortgage rates. Low interest rate and rising home prices in some markets also helped those who have equity to borrow from home equity lines of credit.
It is worth remembering here that one of the triggers for last year's economic shock came from the extremely tight market for credit, both for institutional borrowers as well as for small business and homeowners. I can say from personal experience that borrowing against home equity has been a boon for homeowners who also own and operate a small business.
One factor that has given rise to the current discussion on more economic stimulus is the weak employment market in almost all regions of the US. The national unemployment rate has reached the highest level in 26 years, and that's a major concern. Therefore, the Federal Reserve, the US central bank, and the Treasury need to keep focused on two dark forces threatening the economy, i.e., unemployment or lack of job growth, and inflation fueled by exceptionally low interest rate and the stimulus money.
The Fed has always made inflation control a major cornerstone of its policy protocol over the last three decades, and might have even turned a blind eye to other possible hazards in its preoccupation with inflationary pressures. If one reads the minutes of the Fed's Open Market Committee meetings, it is abundantly clear that the Fed has demonstrated its "inflation phobia" and used the leverage on interest rate and money supply to keep inflation in check. And it has been very successful in this effort, and nobody can deny that.
However, this obsession, or single mindedness, has now been revealed to come with considerable collateral damage: The Fed has failed to regulate the unbridled greed and shenanigans of the financial institutions and investment backs as they played havoc with hedge funds, swaps, and collateralised assets.
The US Senate has just taken up debating a proposal to take the responsibility of consumer protection and bank oversight from the Fed in order to prevent these disasters in the future.
However, as we look at the key price indices, including consumer and producer prices, it is not very likely that they will show any major upward swing in the next year. International oil price is expected to be stable and, barring any major outbreak of violence in the Middle East, supplies are in sync with demand.
Even if we take into account that the Chinese and other emerging countries have recovered very strongly from the slump, their demand alone is not expected to cause any upsurge in oil demand or crude oil price. In light of this likely scenario, US economy is not expected to experience any strong inflationary pressures, if any at all.
Unfortunately, the job market or monthly unemployment figures that dominate the national press is another story. Job losses and the moderate job growth following the first stimulus is the 80-pound gorilla in every political discussion and by-election.
There are several statistics that economists and policy makers use to track the job market and, by implication, the pocketbook condition of the average American. These are: the unemployment rate, weekly job losses, new jobs created, number of first time unemployment insurance claims, duration of unemployment, and the total number of job-seekers out of work.
Recently, two additional measures are also being used: the average number of hours worked per week, and the wage rate or weekly income.
As all economists know, and many others outside the field appreciate, all these measures are related but look at different aspects of the employment market. So when the unemployment rate goes down but the number of new jobs created does not go up, people are puzzled and cry foul, and rightly so.
As British statesman Benjamin Disraeli said a long time ago: "There are lies, damned lies and statistics," and the current outcry about the employment market comes from the frustration with economic numbers.
People need to know whether they should spend money on houses, cars, vacations, businesses, etc., or wait until the jobs market really gets better. However, whichever measure you use, you don't have to be a rocket scientist to figure out that in the current economic situation the outlook for jobs is not very bright.
Many industries are still going under or need to restructure further (auto, heavy industries), others have had excess inventories and are now slowly picking up speed (timber, construction), and some others are just waiting for better times (retail, restaurant, entertainment). In the meantime, more than 7 million people are without jobs, and many of them are concerned about losing their health coverage.
So what's the problem with rolling out another stimulus package? Well, there are three issues that the team of Bernanke, Geithner and Summers needs to work around. The first is the federal debt, which will be impacted by a new round of deficit financing. The second issue is the lurking threat of inflation as more and more money is pumped into the economy. And the third issue is uncertainty regarding the number of jobs that will be created for each dollar spent.
As in all countries, federal spending does not always have an immediate and one-to-one impact in the job market. There are pork barrel projects, leakages and wastage (including big bonuses for bankers and their cohorts), and good projects that are poorly executed. The current national brouhaha over how many jobs were really created and/or saved by the first round of stimulus money provides an interesting backdrop in the debate on the second stimulus.
However, jobs are soon going to be priority number one in the national debate after Afghanistan and health care bills are cleared from the Congress's table. And, while inflation and national debt are potentially volatile issues they will always take a back seat to the primary concern during any election year, i.e., job creation and lack of jobs.