Stimulus Package Not the Path to Economic Recovery

<?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />Washington, D.C., February 14, 2008—This week President Bush signed a $168 billion economic stimulus package. Unfortunately for long-term economic prospects, Congress has failed to enact the more prudent fiscal policy of making permanent the 2001 and 2003 cuts in income, capital gains, and dividend tax.

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It is far from clear we are facing a recession, but we are facing an uncertainty about the economy that is making the market nervous. And part of what is making the market nervous is, ironically, politicians’ urge to do “something,” anything, to save it.

Commerce Department figures released yesterday showed stronger than expected growth in retail sales for January. There has also been some surprisingly strong 4th quarter earnings reports from companies such as IBM. The Federal Reserve's “Beige Book” of industry data notes that in some sectors such as hotels, health care, consulting and engineering, demand has actually been “robust.”

Yet there are still things that concern the market, and many of those concerns stem from Washington. The market is concerned about inflation and unstable dollar, as Bernanke has basically said that he will lower interest rates at will. And it is concerned about the tax cuts expiring — in 2011 by law, and possibly sooner depending on things like election results.

This uncertainty constrains investment. And that’s why it would be so much better reduce this uncertainty by an action such as making the tax cut permanent than a Keynsian temporary stimulus that has been show again and again to be flawed. The late Milton Friedman’s “permanent income” hypothesis demonstrably shows that people do not spend money from a one-time stimuli from the government — in fact if they perceive bad times, they are likely to hoard any extra money they get — but with regard to expectations about their future income.

That’s why he argued that during a recession, the best thing the government could do was raise income expectations by changing incentives through policies such as permanent tax cuts. As he told Radio Australia in the late 1990s, “Cut taxes in order to increase incentives, but there is no need for the government to increase spending.”

Permanent tax and regulatory relief are the best cures for economic doldrums. If the federal government is not gong to do that, it should follow the medical oath, and first do no harm.

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