D.C. ABCs: The 'S' Word Follows the 'R' Word

Stimulus packages are in the works to address recession fears, but it may well be too late.


Economists quip that if you really want to know the future direction of the economy, ignore the numbers and look to Washington instead. When the president and Congress finally get around to talking about juicing a flaccid economy with temporary "fiscal stimulus"—Uncle Sam cutting taxes or cutting checks—an economic upturn is probably already in the offing.

If so, then strong hints that President Bush will put forward a plan to boost the flagging economy at his State of the Union address on January 28—with congressional Democrats surely offering their own blueprint—are welcome news indeed, since the numbers themselves are suggesting that a recession looms. The housing sector is already there. Probably manufacturing, too. And the unemployment rate surged to 5 percent in December, up from 4.4 percent in March. Bad enough to convince Goldman Sachs, among others, that the economy will probably shrink by 1 percent in the second and third quarters, with unemployment rising further to 6.25 percent by year-end. "We have seen clear signs that shock waves have moved from the epicenter of the [housing and credit markets] to other areas of the economy," the firm noted last week.

Cautious Fed. Little wonder the stock market has posted its worst start to a new year since the Great Depression. So what to do, then? There is monetary policy, of course. The Federal Reserve is the de facto designated first responder to economic emergencies. But while the Fed seems likely to further cut interest rates, the crisis of confidence among subprime-spooked lenders might be rendering monetary policy less potent than usual. And fears about inflation and the falling dollar might make the Fed skittish about cutting too deeply. As a result, "there is absolutely a role for fiscal stimulus," argues economist Jared Bernstein of the liberal Economic Policy Institute.

Two options being considered by President Bush are a combination of middle-class tax rebates and credits to bolster consumer spending—serving as a proxy for the homeowner bailout that Bush vowed not to do—and a change in tax laws to more quickly let businesses deduct their investment costs. Both are similar to stimulus measures that were part of Bush's 2001 tax cut package. And U.S. News has learned that House Democrats, led by Nancy Pelosi, may offer a $100 billion stimulus package consisting of $50 billion in tax cuts and $50 billion in new spending. If the feds go the spending route, they could encourage states to implement a temporary "sales tax holiday" and then reimburse them for lost revenue. (A 2001 study from the Congressional Budget Office found that the best fiscal stimulus would be a monthlong holiday from payroll taxes.) Bernstein suggests increasing the federal match for Medicaid payments—which make up 20 to 25 percent of many state budgets—freeing up local resources for, say, infrastructure projects.

As with comedy, the key to fiscal stimulus is timing. And while it may seem that now is the perfect moment to be considering the issue, it might already be too late. "It takes months to formulate a package that could get through Congress," says Alan Viard, a former Fed economist who served in the Bush White House. Congress and Bush are bound to have big differences on specifics, not to mention a possible insistence by Bush that any deal include an extension of his 2001 and 2003 tax cuts. Add in the natural legislative friction caused by neither party wanting to give the other an election-year victory, and at best, nothing gets passed "until at least June," says federal budget expert Stan Collender. "And then nothing gets signed until the fall."

There's your trouble. In an ideal world, a package would already have been passed and waiting for the president to give the green light. Complicating matters further is the possibility that more fiscal action could be blunted somewhat by less action from the inflation-wary Fed. (In 2001, the year of the last recession, the Fed was more worried about deflation, not inflation.) So don't think of potential fiscal stimulus as human growth hormone for a weak economy. More like a can or two of Red Bull.