Richard DeKaser
©2003 All Rights Reserved

In the nine weeks since the fall of Baghdad, leading economic indicators have been bullish: stock prices soared, credit spreads narrowed, financial market volatility declined, and opinion surveys showed markedly improved confidence. Signs of actual improvements are less compelling, but still evident as data are only now trickling out with the characteristic one-month delay.

Private sector employment, for example, increased by 8,000 during May after a smaller gain of 2,000 during April. While nothing to crow about, those small gains compare favorably to huge losses suffered during the winter months. Moreover, all of the jobs added were of temporary workers, which is typically symptomatic of more widespread job gains ahead. And according to surveys conducted by the Institute for Supply Management, businesses reported an increase in orders during May after dismal march-April results.

Policy-makers in Washington are nonetheless unsatisfied with the economy and are pulling out all stops to move things along. Most obvious is the “jobs and growth” package of federal tax cuts and spending increases that became law last month. Looming just over the horizon are reduced withholding taxes, grants to state governments, expanded child credit refunds, and generous incentives for business investment. And while its total cost of $350 billion over 10 years might make it seem small in comparison to the $1.3 trillion tax cut package of 2001, nothing could be more misleading. Leaving aside the questions of whether or not the tax cuts scheduled for future expiration ever happen, the recently enacted tax package—as written—will be far more impactful in the near-term. Specifically, the 2001 legislation provided $98 billion of stimulus over the first 15 months, whereas this year’s legislation will deliver $209 billion (60% of its total 10-year assessment) between now and next year’s election.

For its parts, the characteristically sober Federal Reserve is also pondering what more can be done. Despite the most aggressive campaign of interest rate cuts ever, and its stated opinion that growth is now poised to improve, public utterances by Fed officials are hinting at further actions to prevent deflation. It’s not that they expect deflation to occur. On the contrary, they emphatically point out that it’s unlikely. Just the same, they seem to be saying it may be worth taking out a little “insurance” to be on the safe side.

Of course, most of us seek instant gratification from the things we do, but economic policy simply doesn’t work that way. Monetary policy is given to “long and variable” lags between the time it’s enacted and the subsequent economic results. As a rule of thumb, economists put these lags in excess of six months, which means that the full benefit of its half-point rate cut last No ember is only now being manifest. And with the added stimulus of tax cuts and spending increases just around the corner, we are headed for a textbook case of “policy lag.”

Generally speaking, policy lag refer to the fact that it takes a while for policy-makers to accurately identify problems. Then it takes a while to fashion an appropriate response, a bit longer to implement a policy, and a bit longer still for the results to play out—often after the initial problem has passed. So what does this mean for our readers? If you’ve been worried about economic growth going forward, stop now. The stimulus chickens are about to come home to roost.

Richard J. DeKaser is Senior Vice President and Chief Economist at National City Bank.

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