Sizing Up the Stimulus

01/07/2009 1:00 pm EST

Focus: MARKETS

David Wyss

Adjunct Professor, Brown University

David Wyss, Standard & Poor’s chief economist, evaluates the pluses and minuses of the new Obama administration’s likely new economic-stimulus package.

Continued turbulence in the credit markets and the ongoing recession, which began in December 2007, means that 2009 will likely be a more difficult year than 2008, which saw its fair share of challenges.

We do think Congress and the incoming administration are committed to providing a large stimulus package, which could total [more than] $500 billion. We expect the package to consist of several components such as rebates, similar to the 2008 checks, but aimed more at lower-income households; infrastructure spending, which will probably be the largest component, focused on highway and bridge repair; extended unemployment benefits, and housing assistance to prevent foreclosures. (Recent reports suggest it may also include a large tax cut—Editor.)

Rebates were the major component of the last stimulus package. Although there is doubt about their effectiveness, we think they were largely responsible for the 2.8% gross domestic product (GDP) bounce in the second quarter. It appears that about half of the checks were spent, as we had expected. Another round would probably lead to even less spending, as consumers are more nervous about debt levels.

Infrastructure spending has more impact on the economy because all of the money is spent, but it takes a while to get new projects going. The 2006 Highway Act didn’t boost spending significantly until late 2007, almost a year later. [So,] the surge in spending would not be likely until late 2009, when we expect the recession to be over.

Infrastructure spending does have some real advantages. Perhaps most importantly, it’s hard to import highways, so the jobs created stay in the United States. On the other hand, heavy construction is a capital-intensive process involving high-paid union labor. Especially given government regulations on wages, the number of jobs created per dollar spent is not as high as many think.

[Still,] it is probably better to justify this spending based on long-term needs. We need infrastructure. Bridges shouldn’t be collapsing. Mass transit systems need to be upgraded to get people out of cars to reduce energy use. There are still substantial improvements required for water supply and sewage systems. Extending unemployment benefits is [also] a certainty.

The stimulus package will add to the already-enormous fiscal deficit, which is likely to approach $1.5 trillion in fiscal 2009. In the near term, funding the deficit is cheap. The ten-year Treasury note is yielding only 2.5%, and three-month Treasury bills are yielding ten basis points. Eventually, however, rates will come back to more normal levels, and the interest payments will be a greater burden on the Treasury.

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