Economy may need second dose of stimulus

NEW YORK Thu Jun 12, 2008 2:58pm EDT

Jim Caron, Global Head of Interest Rate Strategy for Morgan Stanley, speaks at the Reuters Investment Outlook Summit in New York, June 10, 2008. REUTERS/Brendan McDermid

Jim Caron, Global Head of Interest Rate Strategy for Morgan Stanley, speaks at the Reuters Investment Outlook Summit in New York, June 10, 2008.

Credit: Reuters/Brendan McDermid

NEW YORK (Reuters) - Even as U.S. consumers raced to spend their tax rebate checks, economists and analysts at a Reuters summit this week said the effect on the economy may be so short-lived that another cash infusion will be needed.

With $57 billion in tax rebates already paid out -- about half the total on offer -- stimulus checks helped push U.S. retail sales up at twice the rate expected in May. The strength, however, could prove fleeting as households contend with soaring gas and food prices and the worst housing slump in decades.

"The tax rebates are coming in, people have some extra money to spend, that should boost the economy to some degree," James Caron, head of global rates research at Morgan Stanley in New York, said at the Reuters Investment Outlook Summit. "I think that's a good thing, but then where's the stimulus in the fourth quarter?"

Caron worries that the shape of the U.S. economy could look something like the letter "W," with a steep decline followed by a tepid rise thanks to the rebate checks, but followed by another slump soon after.

The U.S. Federal Reserve is wary of stoking inflation and has little leeway to lower interest rates further after more than halving them since mid-September, leaving economic measures such as tax cuts and rebates as the stronger weapons.

Martin Feldstein, a Harvard University economics professor and head of the influential National Bureau of Economic Research in Cambridge, Massachusetts, said textbook economic theory holds that one-time tax rebates don't work, but recent experience shows otherwise.

"For a lot of people, seeing the cash sends them right out to the store to spend it," he said. "If the economy is weak a year from now, and this (first stimulus) seems to have worked, I think they ought to do it again."

Consumer spending is the driving force behind the U.S. economy, but until companies are convinced that it is sustainable, they are unlikely to boost manufacturing and resume hiring, limiting the economic benefit.

ELECTION-YEAR POLITICS

Feldstein said he was disappointed that the rebate checks did not seem to boost consumer confidence, which remains at recessionary levels. However, early reports suggest they did lift spending.

The government reported on Thursday that total sales at U.S. retailers rose 1 percent last month, far more than economists had predicted, as people spent their checks. While gas stations certainly siphoned off a big chunk of that spending, even without that retail sales rose at their strongest rate in a year.

Roger Kubarych, chief U.S. economist at The Unicredit Group, said he was surprised that Democrats and Republicans in the U.S. Congress managed to approve the $152 billion 2008 stimulus package in the midst of a heated presidential election campaign "with hardly any kicking and moaning." Whoever wins the November election may have to work that magic again.

"We've got quite a lot of fiscal kick for the second half but it has got a lot of work to do," he said. "I think that it allows maybe 2 percent, 2.5, 3 percent growth in the third quarter but by the end of the year it will be slack. And the next president will reconsider and maybe do another rebate program next year. The economy is not really strong enough without some fiscal kick, and the Fed is pretty much spent."

The economy grew at a sluggish 0.9 percent pace in the first quarter.

Nothing is free, and the current package, worth $168 billion over two years, will add to an already daunting federal deficit. So far, there is no evidence that the rest of the world is balking at cheaply financing ballooning U.S. debt, but the day of reckoning could certainly come and there are those who call for more restraint.

Abby Joseph Cohen, senior investment strategist at Goldman Sachs, said it may be wiser to wait a while and see if the Fed and Treasury have already done enough to revive the economy.

"Is there a need for another stimulus package? I hope not," she said. "We've not yet seen the consequences of the one that has already been implemented. And just like monetary policy has a lag, fiscal policy has a lag, as well.

"In an election year, I think it may be very difficult to structure an additional fiscal policy that makes good economic policy sense," she said.

(For summit blog: summitnotebook.reuters.com/)

(Editing by Leslie Adler)

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