Stimulus Impact
Reading through what little economic news there is this week leaves room for pondering two frequently asked questions: what happens when the effects of the stimulus wear off? and: When is the peak impact anyway?
Well now, as ever in economics, that ‘all depends’.
The problem we have is that the greatest impact on GDP growth rate is already behind us. That was in the third quarter of 2009, when the economy managed to squeak out a meager 2.2% annualized gain. From here on out the impact of the stimulus on the economy’s rate of change will gradually fall away before becoming negative sometime in 2011.
Negative?
Absolutely.
The point is this: when we look at the actual dollars being spent and therefore added to GDP the bulk of the stimulus falls into the next few months, with a peak in the second quarter next year. But the rate of change is affected not by the absolute dollars, but by the incremental dollars. So as the programs kick into gear, as they have been doing this last summer and fall, the acceleration is most marked. Hence the maximum impact on GDP growth rates being back in the third quarter. Now that the stimulus is in full swing it is no longer accelerating, but is maintaining steady activity at a high level. It is therefore contributing a large amount of dollar bulk or spending power to the economy at the moment, but that spending is not increasing much from its already high level. Thus the contribution to growth rates is minor.
The negative part comes at the end of the stimulus program life cycle: as the programs are wound up and the dollar flow diminishes, their impact on growth rates goes into reverse even though the dollar flow still adds to the absolute size of the economy. This deceleration impact is the mirror image of the acceleration that added so much to the third quarter 2009.
So giving a straightforward answer to someone who wants to know when the stimulus has the biggest impact is more nuanced than most people would expect. It depends on whether you measure impact on the rate of growth or on the economy’s overall size.
The growth rate answer is that the peak impact is already past. The overall impact answer is that the peak is yet to come.
Either way, by the middle of 2011 when the programs are dwindling, the impact will be negative.
Which is why we all hope that the private sector awakes from its self imposed slumber before then.
Addendum:
An emerging question concerns the rate of GDP growth for next year.
As you all know I am closer to the pessimists camp than many. This is because I see little evidence of a self sustaining burst of activity in the economy at the moment. To put this in perspective the most optimistic forecast I am aware of has GDP growing an the mid 3% to 4% range. This is a very weak first year ‘surge’. Indeed it really isn’t a surge at all. Consider that the Clinton years saw average GDP growth rates of 3.7% for eight straight years, and you realize quickly just how weak the economy is at the moment. Typically a post recessionary ‘surge’ is in the 7% to 8% range, well above anything we are likely to see. My own view is that we will be lucky to get much beyond the 2.5% level.
Two issues hold us back:
- Unemployment and the consequent overhang of lost earning power and therefore diminished demand.
- Ongoing banking troubles.
It is this second issue that has the most impact. All the evidence from history tells us that recessions caused by financial excess – sub-prime lending, derivatives mayhem, and securitization madness – without fail are longer, deeper, and more susceptible to a ‘double dip’. Since this last recession was brought to us by such a period of financial failure, we have to build into our outloook the lessons of history.
We should also learn from that history and put banking firmly back into the bottle from whence it escaped over the last three decades. Without lashings of re-regulation and lots of downsizing and severe limitations on pay, we can all be assured that the banks will send us off the first cliff they can find. Since we will likely still be paying off the cost of bailing out from this one at that point, the odds of our being able to bail them out again are significantly diminished.
That’s why banking reform is such a vital issue. One that cannot be bungled.
For those of you who want to study that history I strongly recommend the book “This Time Is Different” by Reinhardt and Rogoff, who have been the most reliable source of historical data and perspective throughout this crisis.
