The Bureau of Economic Analysis (BEA) – an arm of the Commerce Department that produces economic statistics – recently reported that the economy contracted 0.3 percent in the third quarter of this year. The downturn in the housing market, which began more than two years ago, continued its downward trend, declining 19.1 percent last quarter. Furthermore, the ongoing credit crisis is now starting to be felt on Main Street. Consumer spending, which has not fallen since 1991, dropped 3.1 percent.
Given the deteriorating economy, many have called on Congress to enact a second economic stimulus bill that would spend tens of billions of dollars on unemployment insurance benefits, transportation spending, and aid to state and local governments. Before Congress acts again, I think it is important to review what Congress has already done and examine how effective each policy has been.
Earlier this year, Congress sent out $300 rebate checks to individuals and $600 to couples, costing taxpayers more than $115 billion. Proponents of the rebates argued that individuals would spend these checks, create an incentive for businesses to remain productive, and prevent the economy from heading into a recession. I opposed the legislation because history and economic evidence suggested rebates would not work. And now, the BEA report seems to confirm my earlier suspicions.
Economist Martin Feldstein, who initially supported this year’s economic stimulus bill, recently wrote “[t]he evidence is now in and that optimism was unwarranted. Recent government statistics show that only between 10 [percent] and 20 [percent] of the rebate dollars were spent. The rebates added nearly $80 billion to the permanent national debt but less than $20 billion to consumer spending. This experience confirms earlier studies showing that one-time tax rebates are not a cost-effective way to increase economic activity.”
In addition to the economic stimulus bill passed earlier this year, Congress approved legislation to create a program to use $700 billion to remedy the real problem underpinning the economic downturn – the credit crunch. Known as the Troubled Asset Relief Program (TARP), it will use these funds to bolster banks so that they can continue lending. It will also help to unfreeze the mortgage market.
At the same time, the Federal Reserve has also started to buy debt directly from financially solvent industrial firms like General Electric, who are able to repay their bills, but have had trouble borrowing because of the fear seizing up the credit markets. The problem in a panic isn’t that bad firms can’t borrow, but that good firms are indiscriminately denied loans that they need to continue operating. The Federal Reserve also reduced interest rates recently by a half a percent to 1.00 percent.
The combination of the TARP and Federal Reserve buying debt, as well as the interest rate cut, are beginning to stabilize the credit markets, loan interest rates are starting to fall, and private banks are starting to lend again – albeit at a very slow pace. It is important to understand that our economy has gone through a very bad financial shock with the bursting of the housing bubble and that it will take time for banks and financial services firms to regain the confidence to lend at sustainable levels. Financial institutions made some very bad decisions extending credit to businesses and individuals who could not repay the loans.
Moving forward, Congress needs to avoid enacting legislation in order to be seen as simply “doing something.” For example, some have suggested providing a massive aid package to the big three domestic auto makers. But there is no good rationale for a taxpayer investment in car companies. The companies have not explained how the taxpayer investment would be used and have not given any assurance that it would be repaid (taking equity positions in these failing companies is not a good deal for taxpayers). The companies have not even justified why $25 billion will be sufficient given their long-term structural problems.
In addition, spending tens of billions of taxpayer dollars on pork transportation projects or sending money to state or local governments will not increase economic growth, but will only serve to increase the indebtedness of our children and future generations.
