Stimulus Gets a Second Wind in Washington

(page 2 of 2)

Economists agree that one of Japan's critical mistakes came in early 1997, when the government allowed a tax rebate to expire and a scheduled increase in the national sales tax to go through. The shock to spending killed a nascent recovery. At other times, Japanese consumers didn't spend when taxes were cut because they knew taxes were going up again soon. Michael Smitka, an economist at Washington & Lee University's Williams School of Commerce, says that in spite of the inconsistency of fiscal stimulus in Japan, it probably prevented the nation's economy from doing even worse than it has.

The lesson from Japan for the U.S.? "We need fiscal stimulus, and we have to be careful to sell it as something that will continue until we are in a clearly self-sustaining recovery," says Smitka. To be sure, starting up a new stimulus package now runs the risk that it wouldn't start hitting until sometime next year. But help is needed right now. Kurl Karl, chief U.S. economist of Swiss Re, says: "I just don't see a lot of logic in it. It would aggravate all the concerns about the deficit. It could get interest rates going up and could harm the economy." Adds Karl: "If it really came in, it would probably be too much, too late."

A second stimulus will be too late if Karl is correct in his forecast that the economy will start to grow by the end of 2009. But if the recession drags on into 2010, more stimulus could be welcome even then. As for the short term, some economists favor quick tax cuts. The trouble with them is that consumers could end up saving rather than spending them, failing to stimulate the economy.

A surer way to provide help very quickly would be to increase federal assistance to the states. That would enable them to head off the draconian budget cuts they will be forced into this year and next. California is in such severe straits, with a projected budget deficit of more than $24 billion, that it has begun using IOUs to pay for state services. Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), and JPMorgan Chase (JPM), among other banks, said they would stop accepting the IOUs on July 10.

Coy is BusinessWeek's Economics editor.

Business Exchange

Track and share business topics across the Web.