Since the start of 2008, the news has been filled with interest rate reductions, stimulus packages and other initiatives designed to jump-start the economy and help the housing market recover. If these developments do have a positive impact on the economy and housing, the furniture industry would surely benefit as well. Many economists, however, are not convinced that the combined effects of stimulus and cheaper money will be able to prevent a recession. It's therefore worth a look at these packages to assess their ability to turn around the current situation.

Background

What brought about the decision to lower rates and implement a stimulus package? The initial action came as a result of sharp declines in global stock markets, which feared the worldwide effects of a U.S. recession. Shortly after those declines, the nation's Gross Domestic Product (GDP) report revealed that the economy grew just 0.6 percent in the final quarter of 2007, confirming that the economy was teetering on the brink of recession. The December 2007 employment report also showed that job growth faltered over the month, adding just 18,000 jobs to the economy and suggesting that employers were becoming more cautious about the future.

Chart 1: Target federal funds rate 

At the same time, however, inflation was becoming a concern once again. In the December-January period, oil prices flirted with a new high of $100 per barrel and gas prices at the pump rose above $3 per gallon. The Commerce Dept. estimated that consumer prices even after excluding energy and food climbed at an annual pace of 2.7 percent in the fourth quarter, well above the Fed's unofficial comfort zone of 1 to 2 percent.

Regardless of that concern, however, the Federal Reserve decided to take an aggressive stance against the softening economic situation. In January, it lowered interest rates by three-quarters of a percent and within days followed with another half-point reduction that brought the Federal Funds Rate down to just 3.0 percent. This was the fifth rate reduction since September and brought rates down by a total of 2.25 percent. The Fed also left open the possibility of further rate cuts if needed to fend off a recession.

Stimulus initiatives

Congress is also working on an economic stimulus plan and is under intense pressure to quickly send a bill to the president. At this writing, the House and Senate bills have yet to reconcile, but will both include tax rebates for individuals as well as incentives for businesses.

The cost of these measures will be in the range of $160-200 billion. Tax rebates will be phased out for individuals earning above $150,000 or couples earning twice that amount. The Senate package is a bit more extensive, extending unemployment benefits and providing tax rebates to those on Social Security and also to veterans on disability.

There are two problems with these stimulus initiatives: first, they could take way too long to be felt in the economy; and second, they could stimulate more than economic growth they could stimulate inflation as well. The problem with using monetary policy (interest rates) to jump-start the economy is that it takes nine to 18 months before the effects of an interest rate reduction are felt in economic activity.

The typical recession lasts two to three quarters, so if we are slipping into a recession now, that recession will be over before the effects of these rate cuts will be felt. Worse, those effects will be felt when the economy is expanding, and could lead to further inflation difficulties.

Monthly Indicators: 

Retail furniture sales ;  Hardwood prices ;  Retail construction spending 

Feasability

The issues with an economic stimulus plan are similar. First, the Congress moves very slowly. Currently, the House and Senate have created different plans that must be reconciled in conference committee before the final bill is sent to the president. By the time rebate checks are actually in the mail (if they do materialize), the economy could be facing a very different set of issues.

Does that mean the Fed and the Congress should do nothing? Probably not. What they do has symbolic meaning that can, in itself, help the economy improve. Perhaps the most important thing they can do, however, is not to turn the battleship, but simply to reduce the pain for those most vulnerable (the unemployed and the poor) in whatever way possible. The economy will ultimately take care of itself.

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