The amount of the fiscal stimulus plan is not some random number. It is not calculus, quantum mechanics or rocket science. It is arithmetic. In Economics 101, every first year student is taught the equation for aggregate demand (a term used to describe total spending in any economy generally referred to as gross domestic product (GDP).
Consumption (C) is all consumer expenditures for goods and services. Investment (I) is private sector spending on capital goods (i.e. a factory or equipment). Government (G) is expenditures for publicly provided goods and services (i.e. military expenditures and social security payments). Exports (X) are revenues for goods and services shipped internationally. Imports (M) are payments for foreign goods and services from places like China, Canada and Mexico.
According to the Bureau of Economic Analysis (BEA), GDP ended the fourth quarter of 2008 at $14.2 trillion.* GDP decreased 4.1% from the end of the third quarter of 2008. If we assume the economy will decline 4% for next year, roughly $568 billion in economic activity will disappear relative to the prior year. In other words, C (Consumption) and I (Investment) will decrease by $568 billion if economy contracts by 4% in 2009. If this is the case, the fiscal policy prescription is to increase G (Government) by some amount to offset that decline. In fact, the government intends to increase G by nearly $787 billion of which 74% will be spent by September 30, 2010.
A poll of economists on February 12, 2009, estimate that the U.S. economy will shrink by 1.9% in 2009.^ I assume their assumptions include some level of fiscal stimulus by the U.S. government. However, the majority of economists are in agreement that the fiscal stimulus plan will not be enough to stop economy from contracting. The Congressional Budget Office (CBO), a non-partisan government agency, reported that the fiscal stimulus plan will increase GDP somewhere between 1.8% and 3.8% in 2009, 1.3% and 3.3% in 2010, and .4% and 1.3% in 2011.^^ The CBO also estimates that the stimulus plan will increase employment between .8 million and 2.3 million in 2009, 1.2 million to 3.6 million in 2010, and .6 million and 1.9 million in 2011. But despite the fiscal stimulus plan we are still facing negative GDP growth and a nasty recession.
In March of 1933, Franklin Delano Roosevelt launched a series of fiscal stimulus measures to stabilize the U.S. banking system and promote economic growth. Past performance is no guarantee future performance, but 1 year later the S&P 500 was 72% higher and 5 years later the S&P 500 was 190% higher than the day FDR become President. Perhaps better times are not too far ahead.
* Bureau of Economic Analysis, Press Release, January 30, 2009.
** New York Times, A Smaller, Faster Stimulus Plan, but Still With a Lot of Money, February 13, 2008.
^ The Economist, February 12, 2009.
^^ Congressional Budget Office, February 11, 2009.
^^^ Robert Shiller, Irrational Exuberance.
Written by Jason McMillen, Chief Investment Strategist, PPWM
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