Asked & Answered: The Economic Stimulus

Burt, from Boise, ID:

Does the government have any other economic stimulus tools besides a third round of Quantitative Easing (QE3)?

Friedenthal Financial:

It’s a great question, and certainly one with many subjective opinions floating around. Here’s a bit of background and several of the ideas circulating, including an outside the box notion.

The Federal Reserve’s first line of defense when it comes to stimulating the economy is of course lowering the Fed Funds Rate (short term interest rates). Since they have already lowered the Fed Funds Rate to zero (technically a range of 0-0.25%), they can’t really lower short term rates any more. They turned then to lowering longer term rates, treasuries as well as other bonds. This has been affectionately dubbed “Quantitative Easing” (rounds 1 and 2). Instead of QE3, at the last Fed meeting (8/9/2011) they announced that they would leave the Fed Funds target essentially at zero for another 2 years! This had a similar effect as quantitative easing, in that longer term rates declined. The benefit of this action over other stimulus tools is that there was no cash outlay by the government.

Even after all of this, there has still been banter about a potential 3rd round of QE, which we don’t think is out of the question. However, would it truly stimulate the economy? We tend to think not….or at least not materially enough. Lower rates stimulate the economy because they make borrowing money cheaper, which creates incentives to spend money. People and businesses aren’t avoiding borrowing money because it’s too expensive. The reason more borrowing (and lending) isn’t going on is because borrowers don’t have the income, credit, and/or collateral to get approved financing. So, lowering long term rates doesn’t really change the situation.

Your question….what “else” can be done?

Income Tax Holiday – While this is stimulative, since tax payers would have more money to spend, it would also increase the budget deficit (decreasing IRS revenue), which has been under significant scrutiny for its current growth rate trajectory.

Payroll Tax Holiday – Similar criticisms to reducing income tax, but targets businesses, hoping relief for businesses will tend to create jobs, thus the stimulus.

Corporate Tax Credit for job creation – A subsidy for businesses to create new jobs would stimulate job creation. Reducing unemployment would certainly be stimulative for the economy. The question is always if the cost of the stimulus would be regained by the government in subsequent revenue (taxes).

Infrastructure Funding – The nation’s bridges, tunnels, roads, railways, subways, etc. are aging. Investing in these infrastructure projects can be productive and certainly creates jobs.

Loosen Bank Capital Requirements – While this could stimulate lending, it reverses the recent course of more stringent capital requirements, which was designed to strengthen the banking system.

Buy Houses – This is the most “outside the box”, and would certainly be criticized for the same reasons as more Quantitative Easing…….it requires more government cash outlay. However, it could be much more effective than QE3, because it would address the two most constricting current economic factors; depressed housing and high unemployment. Buying houses would obviously support housing prices by removing supply. It would also create jobs to manage the properties (to rent), improve the properties where appropriate, and even potentially destroy certain properties, where better use can be ascertained. The government has the ability to hold houses (just like it holds securities in Quantitative Easing) until the market can bear selling them, generally at higher prices. The other stimulative benefit of rising housing prices is that it frees up collateral value to facilitate borrowing/lending. This supports spending as well as small business investment (since that’s where many small business owners get funding).

If you have other ideas, we would love to hear them! In these unique times, it may take some creative thinking to make the real difference.

We hope that helps and provides fodder for discussion.  Please let us know if we can be of further service!

The Friedenthal Financial Team

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