Of rate cuts, tax cuts, and war

The United States economy has moved into something close to suspended animation.

"A no-man's land between recession and recovery," maintains Robert DeClemente, an economist in New York with Citigroup, a huge banking firm.

The anticipation of an invasion of Iraq hangs heavy over the stock market, and probably over decisions by consumers and business to spend and invest. Many economists are again adjusting down their forecasts of economic growth this year. A few talk of a double dip - a return to a recession.

When Federal Reserve policymakers meet tomorrow, they face a tough decision on whether or not to cut a key short-term interest rate again to give the economy a shove. That Federal Funds rate is already at a 45-year low of 1.25 percent.

The interest rate futures market suggests a 50-50 chance the Fed will do so, perhaps by 0.25 percentage points. It also predicts a 100 percent likelihood that rates will fall by half a percentage point by the next Fed meeting May 6.

A month ago, Fed Chairman Alan Greenspan stated: "The heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity."

The widely accepted implication was that the Fed need not do more to boost the economy and that resolution of the Iraqi situation would revive output.

Edward Yardeni, chief investment strategist at Prudential Securities, agrees. He figures the first quarter, also hit by an extremely cold winter, will be weak. Assuming that war starts next week and is quickly over, the second quarter will be "surprisingly strong," with gross domestic product (GDP) rising at a 3 to 5 percent annual rate.

But Paul Kasriel isn't so sure. Some fundamental factors won't go away, notes the Northern Trust Co. economist in Chicago. "The geopolitical risk may be with us long after the fireworks in Iraq," he says, referring to the missile capability of Northern Korea.

Further, it is not so certain that oil prices will plunge as they did in 1991 after the Gulf War ended. Crude supplies are not so abundant this time.

Mr. Kasriel holds that the economy is still adjusting to the bursting of the biggest stock-market bubble ever in the US. The market value of stocks has dived $8 trillion in the past three years.

As a result, household net worth has fallen three consecutive years. Concerned consumers are saving more of their income, putting additional money into bank accounts to reduce risks.

The employment news has not helped consumer confidence. In February, 308,000 jobs overall were lost, 321,000 in the private sector. That was the worst drop since January 1982, a time of deep recession.

If a war in Iraq proves difficult - oil fields are torched, house-to-house fighting in Baghdad proceeds slowly, an occupation requires many troops - it will retard recovery, many economists say.

"I hope all goes well for the president," says Mr. Yardeni. "If it doesn't go well for him, it doesn't go well for the rest of us."

The Bush administration is counting on its proposed tax cuts to give the economy a boost. In Congress, the House is expected to approve a budget resolution this week including the entire Bush economic package. In the Senate, the Republican leadership may have to compromise.

Some Republicans are worried about the huge deficits that the tax cuts could create in the years ahead.

With war and other costs added in, deficits could reach $700 billion per year, says Van Doorn Ooms, an economist with the Committee for Economic Development, a prominent group of educators and active or retired corporate executives.

"Over the medium term, it is not a disaster," he says. "But we will consider it a lost decade." Extra savings to deal with the retirement of baby boomers will be gone as the public debt expands along with the interest burden for the generation ahead.

R. Glenn Hubbard, who last month left the chairmanship of the president's Council of Economic Advisers, reportedly told a Prudential group that accelerating the reductions in marginal income taxes in the 2001 tax-cut bill was "almost in the bag."

Those cuts would be made retroactive to the start of the year in order to provide some stimulus in 2003. Most of the revenue losses from the Bush proposals have their biggest impact in 2004 and later.

Less certain of passage is elimination of income taxes on many corporate dividends

If the war goes well, the president may succeed in winning more of his economic package from Congress, analysts say.

"The economy might not need any stimulus," cautions an optimistic Yardeni.

Last week, the Democratic members of the Joint Economic Committee of Congress proposed their own stimulus package which, they maintained, would have more "bang" for the "buck."

One mathematical model of the economy finds the plan would raise GDP by 1.6 percent and create 1.1 million new jobs by the end of 2003. That, the Democrats say, compares with 1.1 percent additional growth and 600,000 jobs from the president's plan.

Because the Democratic plan avoids significant revenue losses beyond the first year, it would not cause the long-term "unpleasant side-effects" of the Bush plan, says Rep. Pete Stark (D) of Calif.

But in a Republican-controlled Congress, the plan's chances are slim.

You've read  of  free articles. Subscribe to continue.
QR Code to Of rate cuts, tax cuts, and war
Read this article in
QR Code to Subscription page
Start your subscription today