The Short Run Weekly Issue 72

Fellow Shortrunners,

If nine interest rate cuts weren't enough to suggest that the economy is slowing, all one would have to do is turn on any news program talking about job cuts and budget constraints. Talk of the possibility of a recession has turned into conflict over the possible escape routes. A great deal of economic thought has been centered on this very question, and we see that it has become manifested in the actions of the president, state governors, and policy makers across the country. Who is right? More importantly, what is the correct response to our economic woes?

Over the past decade, dominant economic thought has argued that the best tool for approaching minor fluctuations in economic activity was monetary policy. In the United States, there are several advantages to this approach including its non-partisanship and its relatively rapid impact on the economy. After having cut interests rates 6.5% and still facing an economy where economic slowdown and uncertainty are the major risks, some pundits have begun to argue that monetary policy in this economy may be less effective. As supporting evidence, they offer Japan and the US in the 1930's as case studies where interest rates approached zero but tended to be unable to save the economy from recession.

The second mainstream alternative is that of a fiscal stimulus. Fiscal stimuli can take two forms, that of tax cuts (increasing consumers' disposable income), and that of government spending. In an effort to answer a few questions I received last week, I'll just briefly touch upon how they're different, both from monetary policy and from each other. There are several ways in which the government could conduct a fiscal stimulus at the current moment. One option is to pass new tax relief. Tax cuts have the advantage of allowing consumers to spend more of their money as they choose. Unfortunately, in an economic climate such as that of today, many consumers are just as likely to save this extra money as to spend it. A second idea would be to accelerate Bush's current tax plan. This would probably be easier to implement. With slowing growth, either option is likely to lead the government back into deficit spending.

Another option would be for the government to increase its spending. With military and defense spending a new priority, it is likely to do this. This choice has the added benefit that the government will be actively adding jobs and work to the economy. At the same time, the government is less efficient than the private sector and looking long term, increasing the size of the government is likely to hamper economic growth. Increased government spending, like tax cuts, are hard to restrain over time. It's much easier to pass deficit spending than it is to cut government or increase taxes. From a purely economic point of view, having to do with the multiplier effect, a fiscal stimulus taking the form of increased government spending rather than a tax cut should have a slightly larger impact on the economy.

Increased spending can come from the states as well as from the government. Currently, however, many states are facing large budget deficits and the prospect of having to raise state taxes just to stay afloat. Thus it is unlikely that we will see any sort of serious economic stimulus coming from the states. State spending has added flexibility in that it can focus in many areas such as education and state infrastructure which will help to build long-term economic growth prospects. Federal spending could do the same, but we're likely to see our national government's attention devoted to other matters.

There are other methods, however. One which I recently read about is a proposal from renowned Princeton economist, Alan Blinder. His suggestion includes a temporary reduction in sales taxes, which could then be reimbursed by Congress (i.e. the Federal Government). His proposal is unique in several ways. First, it avoids the problem that many states are currently facing, that of tight budgetary restraints, by placing the monetary burden upon the federal government. Second, it strikes right at the heart of the problem. People make economic decisions when they choose to purchase goods or save money. When the opportunity cost of making further expenditures is lessened, people on the whole are likely to spend more money. Finally, his plan is appealing because it is temporary. It could be enacted for a period of time and easily ended, where as some government plans and tax policies are less easily nullified.

Sincerely,
Daniel Hicks

Economic Releases

The data section provides charts and data for the most important economic indicators.

Wholesale Trade: 0.6%

Wholesale sales climbed 0.6% in August, helping inventories to shrink a tenth of a percentage point and decreasing the overall inventory/sales ratio to 1.30. These advances in the wholesale industry are likely to have little economic influence as they will probably be overshadowed by uncertainty surrounding the events of September 11th.

Jobless Claims: 468,000

Initial jobless claims fell to 468,000 for the week. The 4-week moving average, a sort of smoothed value for jobless claims, rose. Part of the reason for the downturn in jobless claims, suggested by other analysts, is that of the seasonal adjustment factors applied to the data.

Import and Export Prices: 0.3% and 0.1% respectively

Import prices rose more rapidly than export prices, causing a slight deterioration in the US terms of trade. That said, the average price of US imports is down nearly 5.2% on the year and is likely helping to prevent further inflationary pressure in the US despite the climate of low interest rates. OPEC is finding that oil prices are being driven down, not by supply increases, but by declining world demand for oil amidst the economic downturn.

Producer Price Index: 0.4% (Core: 0.3%)

The producer price index jumped in September, rising 0.4%. However, with further economic slowdown likely, production costs should be falling as businesses seek to trim costs and inefficiencies.

Retail Sales: -2.4%

Retail sales took a nose dive in September as the fallout from the attack likely dampened consumer sentiment. Nearly every category of the index declined, and the overall decline of 2.4% is relatively hefty. It will be interesting to watch and see if retail sales rebound during October.

ECRI Weekly Leading Index: 115.2

The ECRI Weekly Leading Index remained unchanged from last week's revised release of 115.2. The index has been declining over the past few weeks and currently offers little suggestion of short-term recovery for the US economy.

Classroom

Check out the new classroom section and watch for it to grow and change in the coming weeks as we implement drastic reconstruction to the section. Comment and suggestions as to the best method for this kind of a section would be extremely helpful.

Articles / Book Reviews

Newest Articles:

Balance East and West
- Contributed by Kautilya AKD

Bush's Tax Plan Just Doesn't Cut It
- by Alex Rothenberg

Newest Book Reviews:

Money and Power by Howard Means
The Firm, The Market and The Law by Ronald Coase
Megatrends Asia by John Naisbitt
Geography and Trade by Paul Krugman
Fuzzy Math by Paul Krugman
Growth Theory: An Exposition by Robert Solow