'Tax rebate' checks expected to yield short-term benefits, long-term troubles

Economists foresee renewed economic growth over the next few months, but increased inflation and declining wealth will take a bigger toll.

from the April 28, 2008 edition

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Looking at academic research on the impact of the 2001 tax rebates, Mr. Hunt predicts only about 25 percent of the new stimulus package will be spent. The remainder will be used to reduce debt or increase savings. Moreover, since lower-income families spend half their budgets on lower-priced imports, the actual stimulus to US economy will be a mere one-eighth of 1 percent of GDP. "There is no evidence historically that [rebates] did anything," Hunt says. "I don't think rebates were a good idea."

In addition, since the federal government must borrow the stimulus money from a limited pool of US capital, there will be less money available for business, states, and municipalities to borrow. And they will have to pay a higher interest rate.

Neither Mr. Bethune nor Hunt sound chipper on the economy. Global Insight sees recession in the first half of this year, then a small bounce, followed by more weakness in early 2009, without a "sustainable recovery" until mid-2009.

Hunt talks of "at least another two years of minimal growth."

If either forecast proves accurate, the next president and Congress will not only face the question of what to do in Iraq but what to do further about a lagging economy.

It won't be easy.

The Federal Reserve has moved dramatically to keep the economy going with interest-rate cuts and financial support activities to ease the liquidity squeeze. As a result, the economy's money supply has grown at a 13 percent annual rate over the past three months. If that growth rate lasts much longer, economists' fears of inflation will escalate. Too much money boosts prices.

But even this growth has been "more than entirely neutralized" by a dramatic decline in the velocity of money, that is, how often the money is spent, says Hunt. It sits unused in financial accounts as banks and other financial institutions try to rebuild capital after suffering severe losses from subprime mortgages, collateralized debt obligations, and other fancy financial instruments. In the current massive credit crunch, velocity has declined at a 2.3 percent per annum rate, calculates Hunt. So the Fed's "best efforts are likely to be thwarted," Hunt says.

Adding to the problem, consumers are in poor shape. Assuming house prices drop "only" 30 percent from their peak and stock prices rise just 10 percent from the first quarter level, Americans' loss in real wealth will amount to about $7 trillion, says Hunt. When wealth declines, research shows, consumers spend less. It could be "a drag" on the economy for the next three years.

If that holds true, President Obama, President Clinton, or President McCain will face larger economic challenges than they may have bargained for.

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