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President Bush, anticipating an economic slowdown early in his administration, moved quickly to stimulate the economy by pushing two sizeable tax-reduction programs through Congress. In addition, a substantial increase in spending was also approved by Congress. Without the new president's accurate assessment of the weakening economy, we would be in a substantially worse situation today. As 2002 got underway, the U.S. economy began to recover as a result of these policies of fiscal stimulus. Unfortunately, the Bush policies were not enough to trigger an outright expansion and, as the initial effects of these stimulative programs began to wear off in mid-2002, talk of a double-dip recession emerged. This economy may be more difficult to turn simply because of the magnitude of the budget surpluses, i.e., tight fiscal policy that characterized the late 1990s. Also, slow growth in the money supply and the pervasive weakness in today's business sector is characteristic of an economy in the aftermath of a wave of creative destruction (ie. the tech explosion). Similar waves occurred during the proliferation of the steam engine and electricity with a devastating effect on industries that became obsolete in the process. In response to major declines in corporate profitability, the U.S. stock market, as measured by various broad-based measures, collapsed from record highs. Since reaching a high of 11,582 in early 2000, the Dow Jones Industrial Average fell to 7,592 — or a decline of 34.4% — by the end of the third quarter of 2002. This unexpected decline following the early 2002 market rally also contributed to the fears of a double-dip recession. This combination of a slowing economy, a pervasive weakness in the business sector, and the terrorist attacks on the World Trade Center and the Pentagon changed the outlook for the federal budget. By mid-2002, forecasts for a budget deficit through 2006 replaced expectations for budget surpluses. The fiscal year 2002 budget deficit was $159 billion, triggered by a major decline in revenues and a sharp increase in government spending. The condition of the federal budget has important implications for the economy. When the federal budget is in deficit, it contributes to economic growth. When the budget is in surplus it detracts from economic growth. In other words, deficits imply easy fiscal policy and surpluses tight fiscal policy. The swing in the federal budget from a $480 billion surplus to a $159 billion deficit indicates that fiscal policy has moved from being tight to being easy. One important question is whether or not a persistent deficit in the neighborhood of $159 billion is easy enough to prime the economic pump. One important indicator as to whether or not a budget deficit is sufficient to trigger an economic expansion is the size of the budget deficit as a percent of GDP relative to where the relationship stood during past periods of recession or economic downturns [View these Dept. of Commerce charts.] Since 1970, during previous periods of economic decline, the budget deficit grew to approximately 5% of GDP. If that relationship holds during the current downturn, a budget deficit of 5% of GDP would be in excess of $500 billion. So, fiscal policy is still too tight by historic standards. While a $159 billion deficit may be accepted as being sufficient to maintain economic growth, it is not consistent with the size of the deficit needed to get the economy back on a sustainable growth path. Recent indications of economic weakness attest to the fact that we need more fiscal stimulus — and it should come in the form of a major tax cut. This time around cutting tax rates significantly will be necessary to improve consumer confidence — increased government spending probably won't do that. The stimulus should also be of such magnitude as to offset the weakness in state budgets as well. The tax cut must be bold and must be targeted to jump-start economic growth. Once a sustainable expansion is underway, increased tax collections and reduced government spending relative to GDP will lower the need for large budget deficits. Given the history of budget deficits as a percent of GDP, an annual deficit of at least $500 billion is necessary to help the U.S. economy weather the gale of creative destruction that characterized the beginning of the 21st century. If our financial architects don't move forward on pro-actively stimulating the economy, the budget deficit will increase of its own accord through rapidly rising unemployment benefits and collapsing tax collections as the second leg of the recession takes hold.
— Tom
Nugent is Executive Vice President & Chief Investment Officer PlanMember
Advisors, Inc. |
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experiencing a surprisingly large budget surplus from 1999 through 2001
amounting to over $489 billion, a slowing economy and increased government
spending produced a sharp reversal in this trend. For fiscal year 2002,
the budget swung back into deficit to the tune of $159 billion. Recent
public estimates for the size of the federal deficit now approach $250
billion for fiscal 2003, up from the official estimate of $80 billion
made by OMB earlier this year. Is this change of fortune a cause for alarm?
Hardly. On the contrary, the deficit should be larger if we are truly
serious about getting this economy moving again.
