Rescue plan may produce long-term ills

Stimulus package called harbinger of deficits, inflation

`It's almost inevitable'

Tax cuts, spending on nation's security recall '80s economy

October 07, 2001|By William Patalon III | William Patalon III,SUN STAFF

While the Bush administration's proposed $75 billion rescue package might be what the economy needs, it will likely spur the budget deficits, high interest rates and rising inflation that the country avoided during its record 1990s boom, economists say.

"It's almost inevitable," said Anirban Basu, chief economist for Towson University's RESI Research & Consulting unit. "There's no argument ... that he shouldn't be addressing these national priorities now. The nation faces this threat, and it makes sense to act. But that action demands resources. At some point, we're going to have increased federal debt and federal deficits that will crowd out private investment and lead to higher interest rates" - and inflation.

The fiscal quandary facing U.S. leaders underscores how the Sept. 11 terrorist attacks have altered the American economy possibly for years to come, economists and analysts say.

Instead of reprising the 1990s - when low inflation, cheap money and tremendous consumer confidence produced the longest economic expansion in the country's history and spurred leaps in Americans' living standards - the next few years might better resemble the 1980s: a decade in which prosperity was tempered by big deficits, higher interest rates and little progress by too many households.

"It's clear the long-term fiscal outlook is a lot darker than it was a few weeks ago," said Mark Zandi, chief economist for Economy.com in West Chester, Pa. "It stands to reason that, long term, we're going to see more spending on the military and on security. And that's going to cost the government a pretty penny."

The president's proposed stimulus would employ both tax cuts and new spending to jump-start an economy that most experts say is in recession. Among the provisions would be aid for the jobless, additional tax rebates and tax rules to induce businesses to make new investments in the computers, machinery and other equipment that have made U.S. companies the world's most productive.

Even before the tragedies - with the economy alarmingly weak - President Bush had pushed through a $1.35 trillion tax cut that put hundreds of dollars back into the hands of consumers while rolling back their tax liabilities in years to come. More recently, Congress allocated $55 billion in new spending for disaster-site cleanup, improved domestic security, a military buildup and U.S. airline aid.

With all this spending, analysts are looking for a quicker economic turnaround than was expected before the attacks. They say U.S. leaders have no other course to follow. But the spending packages could further erode projected budget surpluses that become increasingly uncertain with the economy's downturn.

Now there are growing concerns that some of the stimulus initiatives will be tough to halt once enacted. The increased outlays for domestic defense, airline security and a stronger military are sure to stay. Also, some of the tax cuts will be politically difficult to end.

"We're talking about short-run stimulus and spending programs with no real long-term fiscal discipline" that could lead to the annual budget deficits that burdened the U.S. government from 1991 to 1997, Sen. Jon Corzine, a New Jersey Democrat and a former co-chairman of Goldman Sachs & Co., told Bloomberg News.

Remember Goldilocks?

Toward the end of the 1990s, the "Goldilocks economy" label was coined for a reason - everything was "just right" to keep prosperity in place.

With the federal government running a surplus, there was no borrowing to fund a yearly deficit. That made for less competition between the government and private-sector firms looking for financing.

Deficit spending "crowds out private-sector investment," said RESI's Basu. "There's more competition for the capital that lenders put out. With that, [interest rates go] up. What you're looking at, then, is a more inflationary, high-interest-rate environment."

Businesses find it harder and more expensive to get money for expansion or new product development. There's less money to fund the startups that create new technologies, because venture money also comes at a premium. And the higher interest rates go, the more attractive bonds become over stocks, which among other things limits corporations' ability to finance growth using their own equity.

Inflation hasn't been an issue in the U.S. economy for some time, but its return would be an even bigger problem than rising interest rates. As a widespread rise in the price of goods and services, inflation erodes consumer living standards, because paychecks don't go so far. The value of financial assets, such as bonds, can be significantly diminished. Ultimately, the Federal Reserve must raise interest rates high enough to crush the inflation surge, even if it means causing a recession.

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