Goldman Sachs: Why the Economy Needs $600 Billion in Stimulus in 2009

The traditional drivers of an economic rebound may not show up.

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The econ team at Goldman Sachs explains why the traditional drivers of an economic rebound won't help the economy much this time around, and thus we need a $600 billion stimulus package this year alone. Some excerpts:

1) Housing recovery. Prospects for a housing recovery large enough to replicate the usual US cyclical experience are extremely dim given the huge excess supply that hangs over the market. Note in this regard that homebuilding would have to rise by about 33% to add one percentage point to real GDP since the sector has shrunk to only about 3% of US economic activity. Although rebounds of this size have been commonplace over the years, the sector has not faced the extraordinary excess volume of unsold and unoccupied homes that currently exists—about one million units judging from the homeownership vacancy rate, with more in the foreclosure pipeline. Until this excess has been absorbed, a meaningful recovery from the current depressed level of starts is extremely unlikely, even though this level is well below the rate consistent with underlying demographics.

2) Rebound in consumer spending. As people buy new homes and exchange existing ones, they buy appliances and other durable goods to put in them. In turn, this suggests that the poor prospects for a rebound in housing activity could spill over to the consumer durable goods sector. Notably, the last two recoveries had weaker than average contributions from both sectors to real GDP growth (though in the 2001-03 cycle this was partly because the previous setbacks were not as extreme). In addition, if US consumers are determined to raise their saving rates—as they currently appear to be given the fact that they are pulling back in the face of sharp declines in energy prices—then purchases of durable goods, many of which are discretionary in nature, may face strong headwinds in the next couple of years. And, of course, there’s always the issue of credit availability. 

3) Robust hiring. As most observers of the US business cycle are well aware, the last two cycles have featured jobless recoveries. In an increasingly competitive environment where managing costs of production is at a premium, US firms have found ways to squeeze more productivity (and/or perhaps more hours, whether counted officially or not) out of their existing work forces. They have also learned the value of using temporary workers to meet increases in demand that might not prove to be lasting. As a result, we strongly suspect that companies will not be quick to hire new workers in response to increases in demand for their output, though we’d love to be proven wrong on this.

4) An inventory cycle. US firms’ careful attention to inventory management has been evident in the current recession, which began with the real stock of inventories uncharacteristically already in decline. With stocks continuing to shrink, this conceivably sets up a possibility that inventories could provide a more traditional cyclical boost. However, this would seem to require two conditions: (1) that US firms think their inventories are at bare-bones levels when demand starts to pick up and (2) that the improvement in demand appears sustained enough to warrant restocking shelves aggressively. Both seem like tall orders given the excess that overhangs the housing market and the d egree to which US consumers are retrenching and the seemingly structural reasons for that retrenchment.

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