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Economy Needs Straight Talk - and Action

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Mark Weisbrot
Idaho Falls Post Register, April 8, 2001
Knight-Ridder/Tribune Media Services, April 5, 2001
Advance News
(New Jersey), April 25, 2001
Wise County Messenger
(Decatur, TX), April 26, 2001

As the stock market explores new depths in frenzied trading, and hardly a day goes by without the announcement of mass layoffs, the economy is very much on people's minds. Will the market bounce back? Is a recession inevitable? Will a tax cut help jump-start the stalled economy? And what should the Federal Reserve be doing about any of this?

There is a lot of confusion surrounding these questions, and politicians have only added to it by trying to spin the issues to suit their own purposes. The Bush administration has used the slowdown to try to create a sense of urgency around its proposed tax cut. The Democrats, for their part, have exaggerated the impact of the Administration's "talking down" of the economy.

But there are answers to these questions, and perhaps surprisingly, often   considerable agreement within the economics profession -- despite all the jokes about how you could string all the economists arm to arm around the globe and still never reach a conclusion.

Let's get one thing straight at the outset: the stock market and the economy are two different things. The proliferation of 24-hour news channels with those little red numbers, along with millions of day traders for whom the stock market is one big internet casino, has caused a lot of misunderstanding here.

In the last five years or so, an enormous speculative bubble was allowed to grow in the stock market -- not just in the technology-heavy Nasdaq, but in the market as a whole. This bubble is now bursting, as all bubbles eventually must. But even the evaporation of $5 trillion in stock market wealth over the last year does not necessarily have to cause a recession in the economy.

The main impact of the stock market on the economy is through what economists call the "wealth effect:" households reduce their spending when their assets lose value. Economists estimate this effect to be about $3-4 of spending for every $100 of wealth. This means that we would expect a cutback in consumer spending of $150-$200 billion a year, as a result of wealth recently lost in the stock market.

But the government could counteract this effect. When the economy began to turn down, the Washington-based Economic Policy Institute proposed an immediate $500 tax rebate per person (e.g. $2000 for a family of four). That's about $140 billion right there.

Even the Senate Democrats' watered-down version of this policy -- a $60 billion tax cut for this year that includes a rebate of $300 per taxpayer (not per person) and another $150 in tax reduction -- would provide a significant stimulus.

By contrast, the Administration's tax cut, passed by the House of Representatives, would provide very little spending boost for this year. Instead, it would rewrite the tax code to provide the bulk of its relief for the wealthiest taxpayers, phased in over five years. The richest one percent of taxpayers -- with an average annual income of over a million dollars a year-- would get the majority of the money. And the cost of this tax cut, which is estimated over 10 years, would be at least 15 times that of the one-time, $500-per-person rebate.

And then there are interest rates. Federal Reserve Chair Alan Greenspan helped bring on the current slowdown by raising interest rates six times, beginning in June of 1999. Amazingly, despite the steep decline in economic growth, the Fed has still not even taken back the full amount of these unnecessary rate hikes.

Clearly the Fed is not doing its job. But again, on this question we find confusion in the press between the stock market and the economy. When further rate cuts are discussed, the issue is often presented as a question of whether the Fed should help bail out the stock market. This really misses the point.

The goal of Fed policy at this time -- and budget policy, too -- should be to prevent a recession, which would hurt millions of people through increased unemployment and reduced income. Although unemployment remains low by historic standards, this is misleading because it often takes quite a bit of time before an economic slowdown shows up in the unemployment rate. By the time that happens it will be much harder than it is now to avoid a steep economic decline.

A wiser government might have prevented the stock market bubble from inflating in the first place, although no one could stop it from bursting once it was there.  The present government -- the Administration, Congress, and the Federal Reserve -- has plenty of firepower available to head off a full-blown recession. Will they use it?


Mark Weisbrot is co-director of the Center for Economic and Policy Research, in Washington, D.C. He is also president of Just Foreign Policy

 

 

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