Antidotes for the Economic Slowdown

The U.S. economy has unquestionably slowed since the recovery began last summer.  Although some see this as a prelude to the much feared double-dip recession, I believe that it is just a pause in the recovery brought about the by the removal of the fiscal stimulus and the problems in Europe.

The U.S. economy has unquestionably slowed since the recovery began last summer.  Although some see this as a prelude to the much feared double-dip recession, I believe that it is just a pause in the recovery brought about the by the removal of the fiscal stimulus and the problems in Europe.

Nevertheless, there is no reason to take any chances that the slowdown will develop into something worse. I believe there are four stimulus measures that can bring our economy out of the doldrums.

Monetary Stimulus:
Federal Reserve policies have greatly increased the amount of reserves that banks have available since the economic crisis began.  Banks now have over $1 trillion in excess reserves on their balance sheets and are being paid 25 bps on these reserve balances.

With interest rates on safe treasury bills now near zero, banks are holding large quantities of excess reserves because they wish to show a high level of liquidity to investors and regulators.

The Fed should do all it can to encourage banks to lend out these reserves.  One way of doing this is to cut back to zero the interest rate that the Fed pays on excess reserves.

The Fed should also engage in open market policies that encourage banks to extend loans to businesses and consumers.  This can be done by the Fed buying securitized packages of these loans in the open market.

There is little question that the Federal Reserve’s purchase of more than $1 trillion of conforming mortgages (those under $417,000) has helped keep those rates low. Currently the rate on 30-year fixed rate mortgages has fallen to a modern-day low of 4.69%. 

For a median priced house of $220,000, this works about to a very affordable payment of $687/month for a mortgage covering 80 percent of home value.  These low rates have stabilized the housing market.

The Fed, by providing a liquid market for jumbo mortgages as well as other high-yielding credit card and auto loans, will encourage banks to lend in these markets.

Fiscal Stimulus
On the fiscal side there are two additional measures that can be taken:
There is much talk about a new “stimulus plan” to get the economy moving.  But the public rightly doubts whether more government jobs are the right way to go. 

Economists agree that it is the private sector that overwhelmingly creates jobs in our economy.  Therefore we should provide an incentive to employers to add new workers to their payroll by issuing a tax credit to firms who hire. 

This credit can be paid by withdrawing some of the extremely generous unemployment benefits that the government has provided to the unemployed in this economic downturn.

A cut in unemployment benefits is very controversial.  No one is denying the severity of the recent recession and that the unemployed deserve help in this downturn. 

However, unemployment benefits in this recession have been extended to nearly 100 weeks, more than twice the length of any other recession, and the percentage of unemployed being compensated has also risen to record levels. 

My final recommendation is to defer most, if not all, of the 66 reported tax hikes that will take effect in 2011.  Boosting income is the best way to raise consumption; it is bad economics to impose tax hikes when the economy is floundering.

President Obama should consider keeping the tax rates for capital gains and dividend income at current levels for at least another year. Such a move would surprise Wall Street and provide evidence for Obama’s claims that he is not “anti-business.”

Final Words
Even without the further government stimulus, our economy will recover.  But the government can provide a welcome shot in the arm by encouraging banks to lend and firms to hire, and by deferring big tax increases. 

It’s time for the president and the Fed to take initiative to insure our recovery doesn’t stall out.

Jeremy Siegel is currently the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania

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