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Stimulus Aims Two-Phase Jolt at Fading U.S. Economy

Matthew Benjamin Matthew Benjamin
Fri Feb 13, 8:04 am ET

Feb. 13 (Bloomberg) -- The stimulus plan emerging from Congress may jolt the U.S. economy in successive waves: relief to cash-strapped consumers, businesses and states, then a job- creating lift from spending on roads, utilities and public transit.

While the package will take time to have an impact, and unemployment is likely to keep rising for months, it will start returning the U.S. toward growth by the end of the year, economists said.

“Economic activity begins to tick up in third quarter of 2009, but the biggest effect of the stimulus bill is in 2010,” said Yale University economist Ray Fair, who has modeled on his Web site the effects of the legislation Congress is negotiating this week.

Fair and other economists say the first evidence that the plan is working should be visible in consumer spending and retail sales, which they expect will stop declining around mid-year. The next sign may come in business investment, as companies grow more confident about a pick-up in sales. The final signal of success would be a turnaround in a labor market that has lost 3.6 million jobs since the recession started in December 2007.

Jobs Turnaround

“The hope is, with the stimulus, that we actually stop losing jobs by the end of this year,” said Josh Bivens, of the Economic Policy Institute, a Washington research group aligned with labor unions.

The House of Representatives is scheduled to vote today on the $789 billion stimulus plan that President Barack Obama has said he wants to sign by Feb. 16.

Stock-index futures advanced, with contracts on the Standard & Poor’s 500 Stock Index gaining 0.3 percent to 838 as of 7:57 a.m. in New York.

The bill contains a $400 tax reduction for individuals and $800 for families for this year and next, according to House Speaker Nancy Pelosi’s office. Workers will see the relief in the form of a smaller amount of income taxes withheld from their paychecks.

“We can basically change those withholding tables very quickly so people will immediately see some more money going into their bank accounts,” Christina Romer, chairwoman of the White House’s Council of Economic Advisers, said in an interview yesterday on Bloomberg Television.

New Method

Many economists argue that such a delivery method, untested in previous stimulus packages, will be more effective at increasing demand because consumers will be less inclined to save the money or use it to pay debt.

“There is an argument from behavioral economics that people react differently to big lump sums versus these smaller increases in take-home pay they’ll get every paycheck,” said Joel Slemrod, an economist at the University of Michigan in Ann Arbor and an expert on tax policy.

Some economists argue that temporary tax cuts do little to help growth because consumers only alter spending habits based on income changes they believe are permanent. To get them to spend more, the argument goes, tax rates must be lowered for good.

“Temporary tax cuts don’t make people work any harder or get businesses to hire extra workers,” said Chris Edwards, director of tax policy studies at the free-market Cato Institute in Washington. “They don’t change marginal incentives for productive activities.”

Aid to States

Still, other provisions in the bill will have larger, more measurable effects.

One is money for states, most of which are facing budget deficits. Forty-two states and the District of Columbia have mid- year shortfalls totaling $51 billion this year and projected shortfalls of $94 billion for fiscal 2010, according to the Center on Budget and Policy Priorities in Washington.

Because most states have balanced-budget requirements and plunging tax revenue because of the recession, “they’re in terrible shape,” said Iris Lav, who studies state budget issues at the CBPP. Since the crisis began, 38 states have made or planned workforce cuts, Lav said.

“It’s dire; the things they were going to cut is unbelievable,” she said.

The stimulus bill contains about $54 billion to help states with expenses. That may keep layoffs from happening, Bivens said. “Even if money doesn’t get to a state right away, the promise of it can allow them to avoid some job cuts,” he said.

Jobless Benefits

The plan has more than $60 billion to increase unemployment benefits and a boost to food-stamp programs, housing assistance programs and other aid for the hardest-hit Americans.

Funding such programs is particularly effective, said Alan Blinder, a Princeton economist and former vice chairman of the Federal Reserve. “These are hand-to-mouth consumers. If you put cash in their hands they’re going to spend it right away,” he said.

The legislation includes $29 billion for highway construction projects; $16 billion for investments in public transit; $7 billion to expand access to broadband; and $11 billion to renovate the nation’s electrical grid. The measure also would provide $5 billion to weatherize low-income homes and $4.5 billion to make federal buildings more energy efficient.

If the aid to states and consumers and the government spending all have the desired effect, there could be 3.5 million additional jobs in the U.S. economy by the fourth quarter of 2010, according to Fair’s model.

All bets are off if credit markets stay frozen, the economists said.

Treasury Secretary Timothy Geithner outlined a plan earlier this week to help remove illiquid assets clogging banks’ balance sheets and restart lending. It’s far from clear that the plan, which investors criticized as short on details, will work.

“We’re fighting a two-front war,” Blinder said. The economy and the financial system need help in tandem because “if we don’t do both, we’re cooked,” he said.

To contact the reporters on this story: Matthew Benjamin in Washington at ;
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