No instant gratification in U.S. stimulus plan

WASHINGTON Tue Jan 6, 2009 6:52pm GMT

WASHINGTON (Reuters) - Even if U.S. lawmakers give President-elect Barack Obama every penny he wants for a massive spending and tax-cut program, it could be another year before the full benefits filter through to the paralyzed economy.

Details of the stimulus plan are still sketchy, but Obama and his advisers have suggested it will amount to about $775 billion, spread over two years, with the biggest chunk reserved for tax cuts.

The idea is to provide a mix of short- and long-term spending and ease the tax burden on consumers and businesses to spur job growth. Obama has said that signing a big stimulus package would be his first priority when he takes office on January 20, but it will most likely take a few more weeks for Congress to agree on the fine points.

It may take far longer for the jobs to materialize in sufficient numbers to restore consumer confidence and spending, which is the foundation of the U.S. economy.

"Even if there is quick passage, the peak impact of the stimulus may not be felt until 2010," said David Rosenberg, an economist with Merrill Lynch in New York.

"The pullback in consumer and business spending in the coming year will likely be so big that even under the latest leaks on the size of the coming fiscal package, we think it will barely offset half the retrenchment in organic private sector GDP."

Just as the Treasury Department's $250 billion effort to shore up banks did little to get them to resume normal lending, putting money in consumers' pockets won't spur spending until confidence is restored.

The housing and stock market slumps have wiped out $13 trillion in household wealth, Rosenberg noted. That means Obama's tax cut measures may wind up going toward rebuilding savings, which would provide scant immediate economic lift.

Andrew Busch, global foreign exchange strategist at BMO Capital Markets in Chicago, said President George W. Bush's tax cuts earlier this year managed to produce only a couple of months of increased spending because "consumers believed it was a one-time deal."

"Obama wants to make the changes permanent to change consumers' behavior to get them to spend the money. It won't work," he said.

BREAKING THE CYCLE

Fixing the economy has become a bit of a chicken-and-egg problem. Consumers fearful of losing their jobs are cutting spending, which hurts corporate profits and brings more job losses. That in turn leads to rising defaults on mortgages, auto loans and credit cards, and banks clamp down on loans.

Government cannot pick up all the slack.

Since May, when millions of households got rebate checks as part of Bush's stimulus package, disposable income has fallen by $426 billion, or nearly 4 percent. With job losses piling up and many major companies cutting salaries or benefits, that looks set to worsen.

But the public sector can play a big role in breaking the negative cycle and eventually starting a positive one.

Douglas Lee, an economist with consulting firm Economics From Washington, said the rebound could come more quickly than some investors think, although he put the chances of his bullish scenario playing out at just 20 percent.

His thesis presumes Obama's stimulus package passes without a hitch, although an important element is already in place -- lower mortgage rates. The U.S. Federal Reserve has been buying mortgage-backed assets, which has helped to push interest rates down by a full point to around 5 percent.

Refinancing at a rate one percentage point lower would give homeowners about $111 billion in extra cash each year. Even if that money went into savings rather than spending, rebuilding nest eggs would go a long way toward restoring consumer confidence and eventually lifting spending.

Lee also thinks that because Obama's tax cut is likely to be structured differently than Bush's, it may provide a bigger boost to consumption. Instead of a one-time tax rebate check, Obama's plan envisions reduced payroll taxes that would increase take-home pay for two years, giving it a "permanent feel" for consumers.

"The combination of lower mortgage payments and lower taxes means spending will get a substantial boost, even if income growth is weak," Lee said.

(Editing by Dan Grebler)