TCS Daily


To Beat Recession, More Policy Help Likely On the Way

By Kevin Hassett - September 27, 2001 12:00 AM

Last week, the House Ways and Means Committee held an historic event. Chairman Bill Thomas and ranking member Charles Rangel invited a small group of economic experts from both sides of the political spectrum to join them and the other members of the committee for a hearing.

The ground rules for this event were extraordinary. There were none. The doors to the committee room were locked. Staff members were not invited. The press was told to take a hike. Participants in the hearing -- who included former Treasury Secretary Robert Rubin, Brookings economist William Gale, Columbia professor Charles Calomiris, economists Robert Greenstein and Alan Sinai, and yours truly -- were informed that all of their remarks were off the record.

I have participated in many hearings over the years, and usually they are unproductive. Members use the opportunity to make speeches for their constituents back home who watch C-Span, and experts arrive with a sense that they must tow the party line. Last week's event was different. Members and experts participated in a cordial and free exchange of ideas. On that day, everyone in that room sought to discover the truth about the current state of the economy and the best policy options if a recession starts. While the events were off-the-record, it is safely within the ground rules for me to record my own impressions of the lessons of that day. Here they are:

First, the odds that we are heading for a recession are higher now than they were before Sept. 11. There have been a number of historical events that have lead to significant economic disruptions, the Gulf War being the most recent, and the Sept.11th attack looks like it is doing the same thing. Economic activity is dropping off, both because of the economic disruptions caused by airport and border closings, and because consumers are opting to remain at home and stay away from shopping malls.

Second, there is a lot of economic stimulus already in train. The president's tax plan and aggressive Fed rate reductions are providing a boost at this very moment. In addition, increases in government spending attributable to rebuilding efforts and higher military efforts also are providing a strong stimulus. Moreover, futures markets now expect that the Fed will lower interest rates another 50 basis points by the end of the year, providing even more stimulus. Thus, while the economy will certainly weaken, our policymakers have already done a great job of pushing the right policy levers.

But will it be enough? On that we cannot be sure. This suggests that our policymakers have two big-picture options. The first is "do nothing." If they do that, then the economy may well recover on its own. The cost is that we would be accepting the risk that the policies adopted so far would be only partially effective, and that we will have a potentially deep recession. The other option is to have some kind of stimulative tax cut. If we pursue that path, then we lower the chance that we will have a deep recession, but the policy may, at least according to budget hawks, create a long run imbalance between revenue and spending that would have to be offset at a later date.

Looking at the two possibilities, and factoring in that many in Congress are up for re-election next year and are quite fearful that the economy will be in a recession, I would guess that some type of stimulus package will be chosen. The question then arises: What tax cuts will have the biggest bang for the buck at this moment in time?

Two proposals appear to have fairly broad support. First, many on the left support a temporary reduction in payroll taxes. This effort would likely lead to some stimulus, because many low-income workers spend most of their take-home pay. If their paychecks go up because the payroll tax is reduced, then that would likely lead to spending increases. The second proposal, one favored by those on the right, calls for a reduction in the corporate tax rate. This proposal would put cash in the pockets of corporations and likely help them avoid an acceleration of layoff activity.

Given the political process, I would handicap it as a dead heat, and think the most likely outcome is that we get a little bit of both of those measures. If that is true, it might well be a good time to purchase beaten-down equities. Corporate tax rate reductions feed immediately through to the bottom line, and historically have been associated with healthy stock market advances.
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