The Economic Stimulus Package: Will It Work, and for Whom?

Congress and the White House recently settled on an economic stimulus package with unusual speed, pushing the throttle to pull the economy out of a nosedive. Is this just election-year grandstanding, or does economic stimulus really work? And if it can work, what works best?

While some experts argue that priming the economy now is unnecessary, ill-timed or even counter-productive, those who support the concept applaud the design of the recently approved $168 billion package, centered on rebates of $600 to $1,200 for more than 130 million households. "They have moved remarkably quickly, so maybe this time it will, in fact, be well-timed," says Nicholas S. Souleles, finance professor at Wharton. Souleles conducted a study titled, "Household Expenditure and the Income Tax Rebates of 2001," that found a 2001 stimulus package did indeed help the economy recover from recession.

That smaller plan included permanent tax cuts that encouraged consumers to increase their spending, while the current package has only temporary features, he says. But this shortcoming may be offset by today's greater emphasis on getting money to low- and moderate-income people who are especially likely to spend it quickly. "If the new rebate is being more directed towards [financially] constrained households, that ... difference would tend to increase the total spending," he notes. More consumer spending will increase companies' sales, reducing any need for workforce cuts and encouraging growth. At least, that's the theory.

The stimulus should work, suggests Wharton finance professor Jeremy Siegel. But that's what worries him: He thinks the economy is likely to recover later in the year anyway, and that the stimulus package could combine with rising commodity prices to spur inflation. "I do think the economy is going to recover," he says. "The Fed may have to start raising interest rates in the third quarter to offset the stimulus from this package... .This just makes the job of the central bank a little harder."

Housing Bubble vs. Tech Bubble

Offering yet another view, Wharton finance professor Richard Marston thinks today's economic problems are quite different from those of 2001, and likely to be more severe and long-lasting -- and resistant to remedies. The key feature of today's downturn is the collapsed housing bubble, which has a broader effect than the burst tech-stock bubble of 2001, he says.

While the rebates will lead to more spending, Marston notes, the lack of a long-term tax cut will make the stimulus package less effective than the one in 2001. At the same time, the Fed's interest-rate cuts will not work as well because today's credit problems are caused by lenders' fear of risk rather than a shortage of money to lend. Reducing rates will not necessarily reduce that fear. "I think the banking part of this is more problematical this time than it was in 2001 because we're in the middle of a fixed-income crisis -- because people just don't trust each other," he says, adding: "It's very scary, very scary.... I don't see a quick recovery."

It is not yet clear that the U.S. economy fits the technical definition of a recession -- generally seen as two consecutive quarters of economic contraction, plus other criteria -- but there's no doubt it is in trouble. The economy grew just 2.2% in 2007, the lowest level since 1.6% in 2002. In the fourth quarter, it grew at an annual rate of 0.6%, down from 4.9% the quarter before.

Bad economic news has continued this year: On February 15, the government reported that import prices had soared in January at the highest rate since 1983, and that manufacturing was declining. The most recent Reuters/University of Michigan survey showed consumer confidence at its lowest since early 1992.