US stimulus package policy: path to prosperity or road to ruin - Essay Example

US Stimulus Package Policy: Path to Prosperity or Road to Ruin The United s is facing one of the steepest declines in economic activity, and one of the most dramatic shortfalls in budgetary considerations since the Great Depression of the 1930s. Efforts to revive the economic slowdown range from the philosophy that contends government spending is the most efficient way to stimulate the economy, to the conservative viewpoint that argues for a correction based solely on market economics. Spending our way out of the recession is made more problematic by the huge US debt incurred from eight years of Republican spending on two wars and a massive tax cut that failed to sustain any economic improvement. The purpose of this paper is to examine the US stimulus package policy and evaluate its impact on the US dollar, inflation, unemployment, and the myriad aspects of the economy that affect the financial well being and the economic stability of the American public. Historical Context The two problems that have collided to exaggerate the current crisis are the record level of national debt and the declining rate of Gross Domestic Product (GDP) growth. Currently the national debt is approximately $12 trillion dollars, which translates to nearly 75 percent of the GDP (Office of Management and Budget, 2005, p.119). This level has not been seen since the post World War II era, as the debt spiked due to wartime spending. The debt reached a modern low in 1982 at 35 percent of GDP before beginning another sharp increase under Reagan, Bush Sr., and George Bush Jr. (Office of Management and Budget, 2005, p.118-119). The current rising debt has also coincided with a recessive economy. The National Bureau of Economic Research (NBER), the federal agency responsible for determining the official dates of economic expansion and contraction, define a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP" (Dr. Econ: How many recessions, 2008). Negative growth in the fourth quarter of 2007 was followed by two quarters that failed to exceed a 3 percent growth rate. The last quarter of 2008 and the first quarter of 2009 experienced a significant negative rate of growth that exceeded 6 percent (Bureau of Economic Analysis 1, 2009, p.1). Rising unemployment, a decline in real income, and a decline in consumer spending are also indicators of the depth of the recession (Bureau of Economic Analysis 2, 2009; Dr. Econ: How many recessions, 2008). Clearly the US is in a deep economic recession, while facing one of the highest levels of national debt in modern history. The Stimulus Policy Defined In the current crisis, the debate centers on the level of spending that the government should undertake as a means to stimulate the economy. During an economic recession people have the intuition to save their money in the event of future job loss and loss of income. However, this removes money from the economy and makes the situation worse. In addition, letting the market adjust, or rely on it to create jobs, may not be realistic. John Maynard Keynes argued that "the unregulated markets promoted in the laissez-faire approach to economics failed to secure employment in the absence of some government regulation" (cited in Goodman and Cohen, 2004, p.146). However, Keynes's General Theory suggests that substantial spending in the public sector can stimulate the economy during periods of low aggregate demand (Keynes, 2006, p.xlii). Job security, tax cuts, contracts, and a declining unemployment rate will reduce people's propensity for saving and further stimulate spending. These factors are the motivation and rationalization behind the government stimulus package. One of the key features of the economic stimulus package are the tax cuts for the middle class. Supply side advocates have squared off against demand siders in an effort to determine where tax cuts reap the greatest benefit. Supply siders believe that tax cuts for the investment class (the wealthy) will spur investment and increase production, while demand siders contend that the tax cuts should be in the hands of the consumer, which will increase purchasing power and stimulate demand (Garfinkle, 2007, p.163-164). While supply side economic stimulation has been shown to be non-existent during the Reagan tax policies of the 1980s, demand side economics offers a more logical approach (Garfinkle, 2007, p.166). According to Seidman (2005), "Without successful demand-side initiatives, there will be insufficient business and investment opportunities to utilize the expanded venture capital supply" (p.255). The current stimulus package appropriately devotes 40 percent of its resources to tax cuts, largely to the consumer class (Fox, 2009). This is a sufficient portion of the bill that directly stimulates spending and should begin to free up the economy. On top of the tax cuts, 60 percent of the stimulus bill is to be spent on a variety of programs that are designed to create jobs, put money into the hands of the consumer, and improve the psychology of the market. Of the total $787 billion, approximately $250 billion will be spent on infrastructure, education, and green projects (Barrett et al., 2009). These investments will be long term and create a sense of permanency in the mind of the public by giving the workers a sense of job security. Research has indicated that consumers who are more secure about future job prospects will spend more, even if the overall business outlook is less favorable (Bram and Ludvigson, 1998, p.74). Yet, these investments may take some time to get established in the mind of the consumer. As of March 2009, consumer confidence and spending were still significantly lower than the same period a year ago (Jacobe, 2009). As these monies work their way into the economy, confidence should rise and increased consumer spending will follow. The motivation to increase consumer spending has the ultimate goal of creating jobs, and that is the fundamental purpose of the package. In addition to the job creation that is a result of government spending on goods and services, there is $100 billion directed at business for job creation (Cox, 2009). According to Barrett et al. (2009), "The Congressional Budget Office has predicted that the plan will create between 1 million and 3 million jobs". The current unemployment rate is 8.7 percent with 13.5 million unemployed workers, and the job creation portion of the stimulus package could cut the rate to as low as 6.7 percent (Jobs report, 2009). The ancillary jobs created by increased spending could realistically reduce the unemployment rate to below 5 percent. The major criticism of the policy is that it increases the debt to record levels. The interest on the national debt can become a significant portion of the tax revenues if the stimulus fails to increase the tax base as planned. In addition, the debt weakens the value of the dollar abroad, and a lack of confidence could fail to attract additional foreign investments in the future, and could become counter-productive in the drive to create jobs and spur investment. The current level of debt is approximately $12 trillion, and the stimulus package represents about 6 percent of this figure (Knoller, 2009). President Obama recently commented that, "Not just the Chinese government, but every investor, can have absolute confidence in the soundness of investments in the United States" (Knoller, 2009). The short term fears of a large national debt may be exaggerated, especially in light of the alternative of taking no action. The far reaching effects of the escalating national debt, beyond the erosion of confidence, is in the value of the dollar and what the dollar will buy on the global market. One way of handling the massive debt is simply to print more currency. This would result in significant inflation and the creditors would be paid in devalued dollars. A bigger threat is that the world will move away from the dollar as the world's reserve currency. Currently, almost all transactions in the world are tied to the dollar. If the Euro came into a strong enough position, it could replace the dollar as the currency of choice. If oil were tied to the Euro, the weakening dollar would drive up the price of oil. In fact, bank executives in Japan have for several years contended that having the dollar as the reserve currency was economically unstable, and have called for adopting the Euro as the new global reserve currency (Stroupe, 2004). As the dollar becomes weaker, and the situation more unstable, the American consumer could be faced with rapidly rising prices based on imported products. Another negative effect that the stimulus package may have is to increase domestic inflation. With the additional consumer dollars available, producers may opt to increase production to meet demand, or raise prices to lower it. However, the increased level of competition due to globalization makes it more unlikely that producers will raise prices in the face of rising demand (Organisation for Economic Co-operation and Development, 2007, p.199). Most producers are under capacity and will increase production levels before raising prices. In conclusion, the US is currently faced with a shrinking economy and record levels of national debt. Doing nothing and letting the market correct runs the risk of further collapse and a prolonged period of stagnation. The current stimulus package is a mix of tax cuts, government spending, and jobs creation. Economic experts generally agree that demand side economics is the only viable option for a stalled economy, and the US economy is left with few alternatives. Placing billions of dollars in the hands of middle class consumers has a good potential to free the logjam and instill consumer confidence. The dangers of the rising national debt are often overstated and exaggerated, as foreign confidence in the US economy will continue to remain high. In addition, fears of inflation will not bear out in the competitive world of globalization. In times of crisis there are often no perfect solutions. The stimulus package and economic policy offer a well-rounded approach with a high potential for a realistic success. References Barrett, T. et al. (2009, February 14). Stimulus package en route to Obama's desk. Retrieved May 8, 2009, http://www.cnn.com/2009/POLITICS/02/13/stimulus/index.html Bram, J., & Ludvigson, S. (1998). Does consumer confidence forecast household expenditure A sentiment index horse race. Economic Policy Review, 4(2), 59-78. Bureau of Economic Analysis 1. (2009). Economy declines 6.1 percent in first quarter. Washington, DC: US Department of Commerce. Bureau of Economic Analysis 2. (2009). Personal income and outlays. Washington, DC: US Department of Commerce. Retrieved May 8, 2009, http://www.bea.gov/newsreleases/national/pi/2009/pdf/pi0309_fax.pdf Cox, R. (2009, January 6). Green jobs in Obama's stimulus package. Mother Earth News. 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