With news about the state of the US economy getting worse by the day, virtually nobody is now betting on it being able to avoid a recession. Accordingly, the Bush administration last week announced a revival package, which is expected to inject up to $150 billion (about 1 per cent of GDP) into the pockets of consumers through a combination of increased transfer payments and tax rebates. Of course, the package has to be approved by Congress which, in an election year, is bound to be influenced by considerations about how the political dividends from this will flow. The Democrats, who have a majority in both houses, show a willingness to co-operate on the principle, even as there is disagreement on the components of the package. Be that as it may, if President Bush intended to assuage Wall Street with his package, he obviously did not succeed. The US markets dropped sharply on Friday and, while the US took the long weekend for Martin Luther King Day, the rest of the world went into a free fall on Monday and Tuesday. Of course, markets will be markets, but it is critical to take a step back from the carnage and assess the likely impact of the package objectively. Will it be enough to keep the US economy out of recession? | |
| As Ben Bernanke, chairman of the US Federal Reserve Board, observed in his testimony to Congress last week, speed is of the essence. The quicker the additional spending takes place, the more impact it will have in preventing the downslide. It is generally accepted that the quickest way to stimulate spending is through consumers. The main selling point for the Bush package is precisely that it is "timely, targeted and temporary", satisfying the main requirements of a revival measure with virtually no long-term implications for the country's fiscal position. As for the size, Mr Bernanke also suggested that an appropriate fiscal stimulus would be of the order of magnitude of $50 to 150 billion, so the proposal is actually at the higher end of his acceptable range. Of course, he intends to back it up with further interest rate cuts over the course of the year, resulting in a combined fiscal-monetary stimulus that should, at the very least, limit the intensity and duration of a recession, if not help the US avoid it altogether. Why, then, are investors around the world so unconvinced? |
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| One, given the significant decline in house prices, the tax rebate being proposed may well be too small to offset the perceived loss of wealth amongst home-owners, in which category a majority of households fall. Interest rate reductions should help at least arrest, if not reverse, this trend. Two, political circumstances are likely to both delay the implementation of the package and skew it towards more long-gestation public expenditure. This is, of course, merely an apprehension at this point; however, given the impact on markets around the world, it is critical that the Bush administration and Congress very quickly agree on, and put into motion, a "bare essentials" programme that satisfies Mr Bernanke's specifications. The sooner a credible one emerges, the quicker global markets will return to some semblance of normalcy. As it stands, the Bush package appears neither too little nor too late, but political calculations may well render it so. |
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