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Daily Global Commentary

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Fiscal Stimulus Package in a Nutshell

Sun, Feb 15 2009, 22:18 GMT
by Northern Trust Economic Research Department

Northern Trust

Fiscal Stimulus Package in a Nutshell

The final details of the compromise fiscal stimulus package will be available soon – the House passed the $787 billion bill as of this writing. The impact of this larger fiscal package is controversial. But, there is a consensus among experts that an offset to the drop in private sector spending is necessary to lift the economy. Table 1 presents results of the Congressional Budget Office’s (CBO) analysis.

The conservative scenario indicates a 1.4% increase in real GDP on Q4-to-Q4 basis in 2009, after a 0.2% drop in 2008. It appears that in the absence of the fiscal stimulus package the unemployment rate in 2009 would be half a percentage point higher (baseline case) compared with the forecast inclusive of a stimulus package.

Will all be well in the economy as a result of this massive expenditure and tax cut? There is no assurance that self sustaining economic growth will take place in a seamless manner as the extra lift from government spending wanes. Households have cut back on spending in the past few months, with the saving rate at 3.6% of disposable income in December 2008 vs. 0.4% in December 2007 and 1.2% in September 2008. Debt-ridden households are on the road to reduce debt and clean up their balance sheets. The Private/Public Bank supposedly should aid banks to transfer their impaired assets and resume the old fashioned business of making loans. The most favorable scenario is one where banks will be in a position to get the credit machine working eventually as the lift to the economy from fiscal stimulus diminishes. At the same time, support to stabilize the housing market, which is part of the plan, should be successful. In sum, there are many unknowns in this sequence of events that could upset the applecart from the size of the stimulus to the ripple effects and the ultimate working of the banking system. In other words, the fiscal stimulus per se is one part of the whole puzzle with other pieces having to fall in place to get the economy back on its feet.

Federal Budget Deficit in Turbulent Times

This factual comparison is for readers who have been curious about the federal budget deficit from a historical perspective. During the Great Depression, real GDP declined from 1930-33, but grew during 1934-37, and again fell in 1938 (see chart 1). Through these turbulent years, the federal budget deficit as a percent of GDP ranged between 0.1% and 5.9% (see chart 1).

From chart 2, which has the entire history of the budget deficit as a percent of GDP from 1930, we come away with a well known fact that the largest budget deficit occurred during WWII and the largest shortfall of the budget as a percent of GDP during peace time was in 1983 (6.0%).

Moving forward to the present time, the Congressional Budget Office (CBO) estimates that the federal budget will be about 8.3% of the GDP in 2009, without the fiscal stimulus package and larger if the package is included. According to the Strategas Group (see chart in WSJ, Feb. 12, 2009) the deficit including the fiscal stimulus bill would work out to be roughly 13.5% of GDP. The CBO projects that the budget deficit will be 4.9% of GDP in 2010. So, effectively, 2009 will go down in history as the year during which the U.S. economy recorded the largest federal budget deficit as a percent of GDP in a span of eighty years, excluding the war years. The budget deficit as a percent of GDP through the war years of 1942-45 was 14.2%, 30.3%, 22.7% and 21.5%, respectively (see chart 2).

Consumer Sentiment Remains Gloomy

The University of Michigan Consumer Sentiment Index fell to 56.2 in the early-February survey from 61.2 in January. The Current Economic Conditions Index moved up slightly (67.1 vs. 66.5). The Expectations Index dropped to 49.1 from 57.8 in January. The gloomy outlook should not be surprising given the nature of economic reports and financial market conditions. The level of the index is second only to the low readings seen in 1980.

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Published on  Sun, Feb 15 2009, 22:22 GMT