• The US economy is currently in one of the deepest economic recessions since WWII, and a self-reinforcing contraction in employment and consumption makes policy action crucial. The Federal Re-serve has already taken unprecedented steps to unlock the credit markets; further credit easing measures are likely to be implemented as credit markets are still a long way from normal functioning. However, monetary policy is weakened by the breakdown of the monetary transmission mechanism. This leaves fiscal policy with a greater role in getting the US economy back on track.
• President Obama's administration has put forward a substantial recovery package amounting to USD 825bn so far, or approximately 6% of GDP. The package consists of tax relief for households and businesses combined with government spending on investments and state fiscal relief. We estimate that such a package would have a significant effect on growth and could boost GDP growth by ap-proximately 0.7%-point in 2009 and 1.0%-point in 2010. Even with a fiscal boost of this size, we do not expect the US economy to move above trend growth before Q1 2010.
• The cost of the recovery package adds to the already surging budget deficit, which we expect to reach 9% of GDP in FY 2009 and 6% in FY 2010. The flipside of the deficit is a flood of new supply of Treas-ury securities in 2009. We estimate that the combined borrowing needs from the underlying budget deficit, buying of TARP related assets, GSE funding and the Treasury's MBS purchase programme amounts to USD 2.0trn in FY 2009. While the surge in supply will put a floor under Treasury yields, we continue to see the main risk for a renewed surge in bond yields to be a surprise rebound in activity indicators.
