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Money Talks

By Dr. Gregg Dimkoff
Professor, Grand Valley State University
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As I write this article, S&P has just downgraded the credit rating of the U.S. by one notch, the Dow Jones Industrial Index just suffered a terrible week, falling more than 600 points, and Congress agreed to a budget deal pushing meaningful deficit reduction decisions into the future. Clearly, something is wrong, and something has been wrong since near the end of 2007. We are rapidly approaching the start of the fifth year of economic malaise.

So what’s wrong? Why haven’t government economic policies worked to reduce the unemployment rate and stimulate business activity? The short answer is that some have worked well, some have been utter failures and some of the usually powerful policy tools have lost their ability to work.

Here’s one program that worked: TARP. The much-despised Troubled Asset Relief Program bailed out weak banks (including Flagstar, Ionia-based Independent Bank, Mercantile Bank and Huntington Bank). In other words, contrary to common opinion, the bailout was widespread across the country and wasn’t limited to just big mega banks and Wall Street firms. It also bailed out Chrysler and GM. When financial markets quit lending in September 2007, TARP saved the country, if not the world economy, from another great depression. Not only did TARP prevent a depression, the Congressional Budget Office’s most recent estimate is that the net cost of TARP will be $19 billion, all of the loss resulting from bailout money for the auto industry and AIG. The CBO predicts the government will make a $23 billion profit on the money loaned to banks.

Another successful economic policy was the American Reinvestment and Recovery Act of 2009, ARRA for short. You remember the act from the road signs saying the work was being funded by ARRA. By giving states $171 billion, road infrastructure was repaired and 550,000 jobs were created (10,831 in Michigan).

Economic policy isn’t all milk and honey, however. Several programs designed to jumpstart the economy had little long-term effect. The $168 billion tax rebate program in 2008 failed to help. Only one in five recipients spent the rebate ($600 per person and $1,200 for married couples), and surprisingly, that proportion was about the same for all levels of income. Everyone else either saved it or paid off their outstanding debts. The nation’s savings rate spiked when the rebate checks starting arriving.

The 2009 Cash-for-Clunkers program was a dismal failure. Around 690,000 vehicles were junked, creating a shortage of used cars and driving up used car prices to record levels. Taxpayers paid an average of $24,000 per car according to research by Edmunds.com. Yes, sales of new cars increased in July and August, but most of the increase was offset by sales decreases from September through December.

An analysis of the first-time buyers credit for homeowners yields similar results. Both programs can be described as failures compared with the success of TARP and ARRA.

Monetary policy is another government tool used to stimulate the economy. It does so by changing interest rates and the money supply. When the money supply increases and interest rates fall, economic activity is stimulated. Usually. The Board of Governors of the Federal Reserve System has used every trick it has to rev up the economy, but to little avail. It has pushed short-term interest rates to near zero and long-term rates to near historical lows. Yet most businesses and individuals aren’t borrowing. Economists have a phrase for this: “You can’t push a string.” In other words, you can’t make businesses and people borrow just because interest rates are low.

At its last meeting in early August, the Fed announced it would keep interest rates low for perhaps as long as two more years. In other words, the Fed is out of ammunition. It will continue the same policy — very low interest rates — and hope for a miracle.

No one knows what the future holds for the U.S. economy, but using a little hindsight, we know what won’t work: tax rebates and destroying assets. We also know the Fed is close to helpless. That leaves fiscal policy – government spending and taxes. ARRA worked, and we have lots of refurbished roads because of it. If we could re-do economic policy, we would have poured much more money into road projects. Because most economists expect the economy to grow only slowly, now may be a good time to repeat something like ARRA.

Fiscal policy income tax reductions and cuts to the capital gains tax worked in past recessions, and likely would work again. Isn’t it strange we haven’t given them a try? Politics are to blame, and politics may be the nation’s biggest problem right now.