RESEARCH REPORTS. AMERICAN INSTITUTE for ECONOMIC RESEARCH. The President s Stimulus Package: Politics and Economics as Usual

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1 Published by AMERICAN INSTITUTE for ECONOMIC RESEARCH Great Barrington, Massachusetts 123 RESEARCH REPORTS Vol. LXIX No. 2 January 28, 22 The President s Stimulus Package: Politics and Economics as Usual The role of government in the economy has evolved similarly to that of the elephants on the ark. It was originally thought that the elephants should lie quietly in the hold to avoid rocking the boat; but Noah s advisers recommended that they be moved to the deck so that they could rush from side to side to counteract the effects of the waves. President George W. Bush s plan to stimulate the economy would bring forward from 26 to 22 the reduction of the 27 percent income-tax rate to percent (applying to incomes above $46,7 for couples and $27,95 for singles), send checks of $3 to low-income earners not eligible for rebates last year, give extra depreciation allowances to business, and increase the carry-back of deductions for business operating losses to five years from the current two years. Congressional Democrats have countered with demands for more breaks for the poor and fewer for business. Also at issue are health-care tax credits, expansion of unemployment insurance, and tax breaks for victims of terrorist attacks. An Old Story The debate is taking place against a background of mixed messages about economic prospects. No one can be sure how long the recession will last, but many think it will be mild with a good chance of a turn-around before the year s end. It is doubtful that anyone thinks that a compromise can be achieved, a bill passed, signed, implemented, and the provisions made effective in stimulating economic activity before the expansion is well underway. So what s the point? We must ask the question whether any of the proposals are seriously addressed to the recession to which the answer must be a resounding No! The box records that of the last nine recessions, programs purportedly aimed at stimulating the economy, mostly by increased spending, received strong support in seven and were passed in six every one after the recession had ended. New Economics or New Politics? The New Economics of Lord Keynes and his followers is mostly about countercyclical fiscal policy, of how governments can use their taxing and spending powers to achieve economic stability by offsetting fluctuations in private demands. This remains the domi- Too Late for the Economy But Maybe Not for Politics We can assess Keynesian stabilization policy by reviewing the history of fiscal action in the postwar era. In general, all such actions were taken after recovery had begun. Bruce Bartlett [ If It Ain t Broke, Don t Fix It, Wall Street Journal, Dec. 2, 1992] has identified the dates of passage for all of the postwar cyclical fiscal programs. None of them was finally enacted before the date the preceding recession ended, according to subsequent official dating by the National Bureau of Economic Research. Specifically, for the recession beginning in November 1948 and ending in October 1949, President Truman proposed an eleven-point program on July 11, Only one of the points was enacted, an Advance Planning for Public Works Act, signed in October, the month the recession ended. No fiscal action was taken to stem the recession of July 1953 to May Congressional Democrats passed three countercyclical bills to deal with the recession, and President Eisenhower signed them. A highway bill was signed in April, the month the recession ended, and unemployment compensation and rivers-and-harbors bills were passed later that summer. The brief recession of April 196 to February 1961 spanned two administrations. President Kennedy proposed several measures in February 1961, and an unemployment compensation bill was enacted in March. The Area Redevelopment Act was passed in May, and a Social Security bill was passed in June. The recession of December 1969 to November 197 led to one major legislative act, the Public Works Impact Program, enacted in August 1971, almost a year after the recession had ended. The recession of November 1973 to March 1975 prompted several pieces of legislation, the first of which was passed the month the recession ended. That law included tax rebates and extended unemployment benefits. No action was taken regarding the January-July 198 recession other than to remove credit controls. However, the Reagan administration did adopt two countercyclically oriented programs for its recession. The Surface Transportation Assistance Act was enacted in January 1983 and the Emergency Jobs Appropriations Act was also passed in the year after the recession had ended. The recession of prompted a Democratic proposal, which President Bush vetoed. President Clinton s stimulus program, which was submitted after the recession was officially over, was defeated in Congress. William R. Keech, Economic Politics: The Costs of Democracy. Cambridge University Press, 1995, pp

2 Deficit/GNP, (Percent) nant topic of macroeconomics texts in spite of all evidence to the contrary. The Keynesian promise of greater stability was based on the conversion of governments to more enlightened budget policies, specifically that they should not, any more than households, try to balance their budgets every fiscal period. Years of below-average incomes should see deficits to be paid off by savings in good years. Experience has demonstrated that this rhetoric has amounted to nothing more than cynical justifications of deficits that were not and were not expected to be paid off. Another failure of the Keynesian argument was the implication that governments needed to be converted. As a matter of fact, the period of unenlightened dedication to continuously balanced budgets regardless of economic circumstances never existed. Government budgets, by their nature, tend to offset changes in aggregate demand arising from changes in income. They are called automatic stabilizers because declines in income bring smaller tax bills and increased unemployment benefits that turn surpluses into deficits (as occurred in the 19 th century) or increase deficits (in the second half of the 2 th century). Although there was no income tax in the 19 th century, the process worked through excise taxes and tariffs, which fell when lower incomes depressed consumer purchases from home and abroad. The table shows federal government receipts and outlays between fiscal years in which real gross national product fell (omitting those associated with cuts in military spending after the two world wars; several recessions are absent from the table because they were too mild to reduce outputs between full fiscal years). In every case, surpluses or balanced budgets turned to deficits during economic downturns between the 189s and the Great Depression, as well as in , or deficits were increased. This is not to say that pre-keynesian governments were unworried by deficits, but contrary to Keynesian historical revisionism, budgets performed their automatic stabilization function under Presidents Cleveland, Theodore Roosevelt, Wilson, Coolidge, and Hoover about as well as after Keynes. The problem is with discretionary fiscal policies Deficit/GNP, (Percent) Real Gross National Product and Federal Government Receipts and Outlays (bils. $ 1996) For Fiscal Years with Falls in Output, and , Except after Wars Deficit/ GNP Receipts Outlays GNP (%) Discretionary Fiscal Policy The 1964 tax cut was hailed as a triumph of the New Economists. It came during a period of expansion, which turned to inflation and the suspension of the dollar s link to gold. A similar story may be told of the tax cuts in The Revenue Act of 1978 that President Carter aimed at sustaining our economic recovery, which soon turned to doubledigit inflation. The Tax Reform Act of 1986 also cut taxes during an economic expansion and were followed by the largest deficits in history. This is not to say that tax cuts are bad. It is unfortunate that in the modern world even good things have to be dressed in dubious macroeconomic theories. These cuts may be seen as steps in the long process of reducing rates from the confiscatory levels of the 194s raised from 23% in 1929 to 9% on the highest incomes, and still 7% in 198. We would be better off if tax (and spending) cuts were advertised for what they are: letting us keep our income so that we might spend it in ways that efficiently promote our welfare. If this is the President s real goal, his logic is faulty, for if tax cuts are made to depend on economic conditions, they can be raised as easily as reduced. An effect of this logic has been to increase the volatility of budget deficits twenty-five fold between the years before World War I and after the Korean War as shown in the chart and to make them less stabilizing, that is, less inversely responsive to economic conditions. Perhaps the President s goal is more political than economic. The last entry in the box suggests that his father cared less than his successor for the unemployed. The son must be seen to be doing something.

3 2 PRIMARY LEADING INDICATORS [11/1] M1 Money Supply (1) 5 M2 Money Supply (1) [11/1] Month Percent Change in Sensitive Materials Prices (6) +5 5 [8/1] 2 [/1] New Orders for Consumer Goods (3) Contracts and Orders for Plant and Equipment (4) [1/1] New Housing Permits (3) (thousands) [11/1]

4 .9 PRIMARY LEADING INDICATORS (Continued) Ratio of Manufacturing and Trade Sales to Inventories (3) Vendor Performance: Slower Deliveries Diffusion Index (2) (percent) [9/1] [11/1] [11/1] Index of Common Stock Prices (2) (constant purchasing power) 46 Average Workweek in Manufacturing (3) (hours) [11/1] Initial Claims for State Unemployment Insurance (3) (thousands, inverted) [/1] Month Percent Change in Consumer Debt (4) [9/1] Notes: 1) Shaded areas indicate recessions as dated by the National Bureau of Economic Research. 2) The number in parentheses next to the name of a series is an estimate of the minimum number of months over which cyclical movements of a series are greater than irregular fluctuations. That number is the span of each series moving average, or MCD (months for cyclical dominance), used to smooth out irregular fluctuations. The data plotted in the charts are those MCDs and not the base data. The number in brackets is the latest month for which the moving average is plotted. 3) The insets in selected charts show recent trends more clearly. These insets have arithmetic scales, even when the main chart is plotted on a ratio scale. 8

5 6 PRIMARY ROUGHLY COINCIDENT INDICATORS Nonagricultural Employment (1) (millions) [12/1] Index of Industrial Production (1) (1992 = ) [12/1] [/1] Personal Income in Manufacturing (2) [9/1] 1,2 6 Manufacturing and Trade Sales (2) Civilian Employment as a Percentage of the Working-Age Population (2) [11/1] Gross Domestic Product (1) (quarterly, constant dollars, billions) [9/1]

6 6 PRIMARY LAGGING INDICATORS 14 [11/1] Average Duration of Unemployment (2) (weeks, inverted) 16 [/1] 1, 8 1,15 Manufacturing and Trade Inventories (1) 1, Commercial and Industrial Loans (1) [11/1] [11/1] Ratio of Consumer Debt to Personal Income (1) Percent Change from a Year Earlier in Manufacturing Labor Cost per Unit of Output (2) [/1] - 2 Composite of Short-Term Interest Rates (1) (percent) [12/1]

7 BUSINESS-CYCLE CONDITIONS Although the base data for eleven of our leading indicators of economic activity increased this month, the improvement is not yet reflected in the percent of AIER leaders that are expanding. Nonetheless, those gains cannot be dismissed, as the indicators lead time for recovery generally is much shorter than for recession, especially since the laggers show few signs of the bottlenecks that would thwart a recovery. Earlier this month the Conference Board announced that its leading index increased by 1.2 percent in December, pushing the index level back above the pre-recession level. Also this month, Federal Reserve Chairman Alan Greenspan remarked that there were tentative indications that the contraction phase of this business cycle is drawing to a close, later clarifying his view that he thought the economy was in the process of turning. Although the improvement among our leading indicators of economic activity is too weak to signal recovery, they provide a glimmer of hope. The base data for eleven of our twelve primary leading indicators increased since last month. However, only the two monetary series, M1 money supply and M2 money supply, have an upward cyclical trend. (M1, M2, and all other dollar-denominated series are reported in constant dollars.) Although M1 remains below its September peak (when the Fed flooded the banking system with liquidity), M2 reached a new high. The other financial series, the index of 5 common stock prices, increased for the third time in as many months and was upgraded to probably contracting. The series is above its pre-september level but well below its August 2 peak, as can be seen in the historical charts that accompany this report. Both the average workweek in manufacturing and the percent change from 3 months earlier in consumer debt were upgraded from clearly contracting to probably contracting. The manufacturing workweek rose by.4 hour to 4.7 hours. Factory overtime was also up, rising.2 hour to 3.9 hours. After contracting for nine months, the pace at which consumers are taking on new debt increase by 1. percentage point to 2.1 percent. Vendor performance, which measures the percentage of purchasing agents reporting slower deliveries from their suppliers, increased.7 percentage point to 48. percent but the series 2-month moving average declined. The indicator remains appraised as probably contracting. Despite upticks in their base data, three series remain appraised as clearly contracting. Although the percentage change from 3 months earlier in sensitive materials prices remains negative (indicating that prices continue to decrease), the rate of price decrease has slowed. However, this highly volatile series will require several sustained months of improvement before the cyclical trend of its 6-month moving average reverses direction. New orders for consumer goods increased for the second straight month, partially reversing the series plunge in September. Initial claims for unemployment insurance, which is plotted on an inverted basis, increased by 35, to 461,. Nevertheless, the series 3-month moving average reached a new low. New housing permits in December increased 4. percent to a seasonally adjusted rate of 1,653,, a change sufficient to render the series indeterminate. Building permits for 21 were 1. percent above the figure for 2. Housing starts for the year increased 2. percent; completions were unchanged. The ratio Statistical Indicators of Business-Cycle Changes Change in Base Data Cyclical Status Sep. Oct. Nov. Dec. Primary Leading Indicators Nov. Dec. Jan M1 money supply M2 money supply Change in sensitive materials prices New orders for consumer goods -? - - Contracts and orders for plant and equipment??? New housing permits -? -?? - + Ratio of manufacturing and trade sales to inventories??? nc Vendor performance -? -? -? Index of common stock prices (constant purchasing power) - - -? Average workweek in manufacturing - - -? Initial claims for unemployment insurance (inverted) Change in consumer debt - - -? 11 of manufacturing and trade sales to inventories jumped 3.8 percentage points and is now four months from its trough. Although the series remains indeterminate, that sales are growing faster than inventories is a positive sign for the beleaguered manufacturing sector. No new data for contracts and orders for plant and equipment were available. The series remains indeterminate. Given this month s changes, 22 percent (two out of nine) of the primary leading indicators for which a cyclical trend is apparent are appraised as expanding, compared with 2 percent (two out of ten) last month. The cyclical score, which is based on a separate, purely mathematical assessment of the leaders, increased to 41 from last month s revised score of 39. Despite upturns in the base data for eleven series, and four upgrades, both indexes suggest that business activity is likely to continue contracting in the near future. Although one month of good news does not constitute an upward trend, the gains are not to be ignored as the indicators lead-time for recovery generally is much shorter than for recession. The only good news among the six primary roughly coincident indicators was the 4. percent increase in the base data for manufacturing and trade sales, which Percentage expanding cyclically Primary Roughly Coincident Indicators Nonagricultural employment Index of industrial production Personal income in manufacturing Manufacturing and trade sales -? - -? Civilian employment to population ratio Gross domestic product (quarterly) Percentage expanding cyclically Primary Lagging Indicators - r Average duration of unemployment (inverted) Manufacturing and trade inventories Commercial and industrial loans Ratio of consumer debt to personal income? Change in labor cost per unit of output, manufacturing + +? Composite of short-term interest rates nc No change. r Revised. Percentage expanding cyclically Under Change in Base Data, plus and minus signs indicate increases and decreases from the previous month or quarter and blank spaces indicate data not yet available. Under Cyclical Status, plus and minus signs indicate expansions or contractions of each series as currently appraised; question marks indicate doubtful status when shown with another sign and indeterminate status when standing alone.

8 was sufficient to raise doubt that the series is contracting. Of the rest, all reached new lows and are contracting, suggesting the economy is still shrinking. Nonagricultural employment decreased 124, in December, bringing total job losses to 1.4 million since the recession began in March, and 1.8 million for the year. Large declines continued in manufacturing, air transportation, and retail trade while health services and government recorded gains. Industrial production declined.1 percent. Utilities output, which increased.4 percent, has a better record of tracking overall economic growth than mining production, which decreased.8 percent, because the latter is more affected by energy prices than by changes in the strength of the economy. Personal income in manufacturing decreased for the eleventh straight month, falling.7 percent. In contrast, the ratio of employment to the working-age population increased for the first time since September, but the series moving average continues to weaken. According to revised estimates, Gross Domestic Product decreased at an annual rate of 1.3 percent in the third quarter of 21, a larger decrease than reported in earlier estimates. Despite the upgrade to sales, the percentage of coinciders for which a trend is relevant remains at zero for the third consecutive month. Among the six primary lagging indicators, continuing decreases in personal income and higher consumer debt pushed the ratio of consumer debt to income to 18.9 percent, a record high. To the extent that this ratio reflects the burden of financing debt, it appears that consumers may be increasingly unable, if not unwilling, to borrow even more to finance new spending. The series is appraised as clearly expanding. The other five laggers are contracting cyclically. The average duration of unemployment increased to 14.5 weeks. (The series, plotted inversely, decreased.) Labor markets remain soft. The number of unemployed persons reached 8.3 million, and the jobless rate rose to 5.8 percent. Although more reentrants are having increasing difficulty finding jobs, the levels of unemployed job losers, job leavers, and new entrants were unchanged. Manufacturing and trade inventories decreased 1.3 percent in October. Reduced inventories have helped restore balance in the manufacturing sector, thus reducing the chances of a recovery-thwarting bottleneck from developing. Commercial and industrial loans also fell, decreasing 1.7 percent, owing to both weak loan demand and tighter credit standards. Although the 12-month percent change in the labor cost per unit of manufacturers output remains positive (i.e., unit costs continue to increase), the rate of increase has slowed sufficiently to downgrade the series from probably expanding to clearly contracting. The composite of short-term interest rates reached yet another low, falling 19 basis points to 1.77 percent. The Percentage of AIER Leaders Expanding Cyclical Score of AIER Leaders Fed, which cut interest rates eleven times last year, meets January Overall, 17 percent (one out of six) of the lagging indicators are appraised as expanding, down from 33 percent last month (two out of six). Except for the comsumer debt series, the current trend in the laggers clearly favors a recovery ' '5 Order Your Bound 21 Research Reports We are pleased to offer Volume LXVIII (21) of Research Reports in a paperbound edition to all Annual Sustaining Members at the special pre-publication price of just $5 per copy ($ after February 28, 22). This volume includes all issues of Research Reports for 21, plus a convenient index. To place your order, complete the form below (if you prefer, you may photocopy this page or simply write your request on a sheet of paper) and return with your check payable to AIER, P.O. Box, Great Barrington MA Enclosed is $ for bound copies of 21 Research Reports ($5 each). Please mail my order to: Name Street Address State ZIP Code We accept the cards shown or your personal check made out to "AIER". CREDIT CARD NUMBER American Express Master Card Month Year Discover Visa EXPIRATION DATE Signature PRICE OF GOLD Jan. 27 Jan. Jan. 17 Jan. 24 Final fixing in London $ $264.9 $285. $279.2 Research Reports (ISSN ) (USPS ) is published twice a month at Great Barrington, Massachusetts 123 by American Institute for Economic Research, a nonprofit, scientific, educational, and charitable organization. Periodical postage paid at Great Barrington, Massachusetts 123. Sustaining memberships: $16 per quarter or $59 per year. POSTMASTER: Send address changes to Research Reports, American Institute for Economic Research, Great Barrington, Massachusetts