U.S. economy: Stimulus plan not a quick fix

We shouldn't expect the stimulus plan presented by Congress to the President to bring an early end to dismal data reports on the health of the economy. Conditions will continue to worsen for at least the next two quarters. Indeed, most analysts expect annualized growth in real Gross Domestic Product (GDP) to dip by as much as 5 percent in the current quarter. This will be the weakest quarter for GDP growth since a decrease of 6 percent logged in the first quarter of 1982.

We shouldn't expect the stimulus plan presented by Congress to the President to bring an early end to dismal data reports on the health of the economy. Conditions will continue to worsen for at least the next two quarters. Indeed, most analysts expect annualized growth in real Gross Domestic Product (GDP) to dip by as much as 5 percent in the current quarter.

This will be the weakest quarter for GDP growth since a decrease of 6 percent logged in the first quarter of 1982. Moreover, in spite of the stimulus plan, real GDP is projected to contract for the year as a whole in 2009. This will be the first negative growth year since 1991, when GDP also shrank, but by less than one quarter of one percent. The likely magnitude of the decline this year will approach (or exceed) two percent, similar in size to the GDP drop in the recession of 1982.

Although the stimulus plan is described as a total package of $787 billion, that amount is spread over the first three years, followed by smaller impacts through 2019. The major three year component totals $719 billion. Only about one quarter of the $719 billion will be targeted for 2009. Of the $185 billion portion set for 2009, tax credits and various aid programs for individuals (such as food stamps) make up almost two-thirds of the plan for this year.

While this relief will be welcomed, it is not enough to jump-start auto sales or purchases of other durables. Analysts typically put the multiplier effect of tax credits at less than one, as consumers pay off debt or add to savings, rather than spending. Aid to state and local governments in the plan for the first year is $40 billion.

This may preserve jobs and prevent essential services from being cut, but the overall effect is to prevent conditions from getting worse, rather than stimulating new jobs and growth. Infrastructure spending in 2009 under the plan is $29 billion, rising to $83 billion in 2010. Most analysts believe the multiplier effects and job creation will be greatest for the various construction and other infrastructure components of the plan.

Overall, the plan is expected to preserve or create up to three million jobs. However, this will simply offset the 3.5 million jobs already lost since December of 2007, when the recession began. Some observers have commented that one benefit of the stimulus plan may be renewed consumer confidence.

It is unlikely confidence will strengthen by much just because consumers finally see some action by Congress in response to the downturn. There are plenty of reasons why consumer confidence will remain weak, including rising unemployment, a stagnant stock market, tight credit conditions and — importantly — falling home prices.

The stimulus plan does little to counteract the housing downturn and falling home prices. The expectation among many economists is that home prices will fall by another 10-15 percent in 2009, and housing construction will not recover until perhaps the end of the year, bringing a conclusion to a four year decrease in home building.

Forecast Update

The U.S. forecast has grown still more pessimistic this month. Real GDP is expected to decrease by 5 percent at an annualized rate in the current quarter, and by an additional 2 percent in Q2. GDP is projected to be barely positive in Q3 of this year, and accelerates to 2 percent growth at year end. GDP is forecast to grow by 2 percent in 2010.

The expectation that the recession will not continue into 2010 is currently the dominant view among analysts. In a recent survey of 50 leading economists by Blue Chip Economic Indicators, 90 percent said they thought the recession would end in 2009, although most expected unemployment to continue to rise into 2010.

The recovery scenario is based on a turnaround in consumer spending as tax credits and other programs kick in, and housing finally bottoms out. In the fourth quarter of 2009, the forecast calls for consumer spending to rise at an annual rate of 2.0 percent, and residential building starts up again as the housing slump ends. Housing in 2010 is currently projected to increase by 20 percent.

With current inventory levels of 10 months of unsold homes, one might wonder if this kind of rebound is possible. But this increase would be similar to recovery from previous deep housing downturns. In January of 1991, there was also 10 months inventory of unsold homes. By January of 1992, the inventory was equal to 5 months sales. During 1992 single-family housing permits jumped by 20 percent.

Two previously strong components of GDP growth in 2008 (nonresidential building and exports) will remain weak in 2009 and 2010, subtracting from GDP. Based on all available information as of February, it seems certain the recession will be the longest and deepest in the post-war period. And it is quite possible that additional tweaks to the stimulus plan will be necessary in the next few quarters to enable (and convince) consumers to spend and business to invest.