Wednesday, January 21, 2009

The Economic Impact of the American Recovery and Reinvestment Act

Mark Zandi, the chief economist at Moody's, analyzed the effects of the federal government stimulus spending program in the January 21, 2009 article "The Economic Impact of the American Recovery and Reinvestment Act ." Here are the conclusions of his report:

A long history of public policy mistakes has contributed to the financial and economic crisis. Although
there will surely be more missteps, only through further aggressive and consistent government action will
the U.S. avoid the first true depression since the 1930s.

In some respects, this crisis has its genesis in the long-held policy objective of promoting
homeownership. Since the 1930s, federal housing policy has been geared toward increasing
homeownership by heavily subsidizing home purchases. Although homeownership is a worthy goal,
fostering stable and successful communities, it was carried too far, producing a bubble when millions of
people became homeowners who probably should not have. These people are now losing their homes in
foreclosure, undermining the viability of the financial system and precipitating the recession.

Perhaps even more important has been the lack of effective regulatory oversight. The deregulation that
began during the Reagan administration fostered financial innovation and increased the flow of credit to
businesses and households. But deregulatory fervor went too far during the housing boom. Mortgage
lenders established corporate structures to avoid oversight, while at the Federal Reserve, the nation's most
important financial regulator, there was a general distrust of regulation.

Despite all this, the panic that has roiled financial markets might have been avoided had policymakers
responded more aggressively to the crisis early. Officials misjudged the severity of the situation and
allowed themselves to be hung up by concerns about moral hazard and fairness. Considering the
widespread loss of wealth, it is now clear they waited much too long to act, and their response to the
financial failures in early September was inconsistent and ad hoc. Nationalizing Fannie Mae and Freddie
Mac but letting Lehman Brothers fail confused and scared global investors. The shocking initial failure of
Congress to pass the TARP legislation caused credit markets to freeze and sent stock and commodity prices

Now, a new policy consensus has been forged out of collapse. It is widely held that policymakers must
take aggressive and consistent action to quell the panic and mitigate the economic fallout. An unfettered
Federal Reserve will pump an unprecedented amount of liquidity into the financial system to unlock money
and credit markets. The TARP fund will be deployed more broadly to shore up the still-fragile financial
system, and another much larger and comprehensive foreclosure mitigation program is needed to forestall
some of the millions of mortgage defaults that will occur otherwise. Finally, another very sizable economic
stimulus plan is vitally needed. While there will be much more discussion about the size and mix of
government spending increases and tax cuts to include, the House Democratic plan is a very good starting
point. This is important, for while such debate is necessary it must be resolved quickly. Unless a stimulus
plan is implemented beginning this spring, its effectiveness in lifting the economy will be significantly

Fiscal stimulus does carry substantial costs. The federal budget deficit, which topped $450 billion in
fiscal year 2008, could reach $2 trillion in fiscal 2009 and remain as high in 2010. Borrowing by the
Treasury will top $2 trillion this year. There will also be substantial long-term costs to extricate the
government from the financial system. Unintended consequences of all the actions taken in such a short
period will be considerable. These are problems for another day, however. The financial system is in
disarray, and the economy's struggles are intensifying. Policymakers are working hard to quell the panic
and shore up the economy; but considering the magnitude of the crisis and the continuing risks,
policymakers must be aggressive. Whether from a natural disaster, a terrorist attack, or a financial calamity,
crises end only with overwhelming government action.

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