The Hangover - 10/02/09

October 2, 2009

The Hangover
By Doug Kass, The Edge

The stimulus efforts don't have a meaningful multiplier effect, and they will likely leave us with a wicked hangover.

We face unknown ramifications for our currency, interest rates, inflation and the funding of U.S. debt.

The accepted notion of steady, self-sustaining growth might be challenged in the months ahead.


Yesterday's Wall Street Journal editorial by Robert J. Barro and Charles J. Redlick, which is a working paper for the National Bureau of Economic Research, addresses something I have written about extensively -- namely, whether programs such as cash for clunkers, housing tax credits and other stimulus efforts provide any multiplier effect above one.
I have argued (and the authors do as well) that the stimulus spending proposals above, particularly in their current form, don't have a meaningful multiplier effect but, more importantly, borrow from future sales of automobiles, housing and, generally speaking, retail sales. It seems to me that the recent slowdown in car sales and housing sales activity provides some temporary support to my conclusion.
It also seems to me that, following decades of credit expansion and financial inventiveness that (among other things) has lifted consumer debt and debt service to record levels, the consensus for a consistent, smooth and certain recovery in the economy and in corporate profits (which have elevated P/E multiples by over 40% from the lows) might be approached with a more conservative stance. The baton handoff from private sector contribution to growth to an overwhelming dependency on the public sector to stabilize and fuel economic activity may not be as easy as investors appear to be accepting in their forecasts. And its aftermath, with its due bills, could hold unknown ramifications for our currency, interest rates, inflation and the funding of U.S. debt (among other issues). Finally, other the effects of other nontraditional headwinds' loom over the horizon -- for instance, the disrepair of state and local governments and the prospects for higher marginal tax rates.
I believe that the bulls' response will be that their baseline assumption for growth already incorporates a sluggish and shallow slope vis-a-vis prior cycles. Nevertheless, might even that expectation be too optimistic?
My contacts with companies suggest that the consensus forecast of steady and self-sustaining growth, especially as it relates to hiring, might be challenged in the months ahead.
Here is today's Washington Post discussion on a possible post-stimulus hangover.
And here is a synopsis of the aforementioned Wall Street Journal piece:
The existing empirical evidence on the response of real gross domestic product to added government spending and tax changes is thin. In ongoing research, we use long-term U.S. macroeconomic data to contribute to the evidence. The results mostly favor tax rate reductions over increases in government spending as a means to increase GDP....
The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending. Defense-spending multipliers exceeding one likely apply only at very high unemployment rates, and nondefense multipliers are probably smaller. However, there is empirical support for the proposition that tax rate reductions will increase real GDP.