One Rebate Isn't Enough - A Commentary By Professor Robert J. Shiller
"One Rebate Isnít Enough"
By Robert J. Shiller
Published in the New York Times on June 29, 2008
Read the article in its original context on the New York Times website.
Tax rebates have been arriving in bank accounts and mailboxes, and will eventually put more than $100 billion into the hands of consumers. The hope is that by spending the money, they will lessen the risk of economic disaster from the subprime crisis.
Have the rebates, now mostly distributed, achieved their objective?
It's not very likely. The rebates may be helping the economy, but the stimulus they are providing is certainly too small to make a real difference. More will be needed, perhaps much more, before the economy is truly on safe ground. From the outset, government officials considered the tax rebates as a kind of insurance for the overall economy. In January, just before Congress passed the stimulus bill authorizing the rebate checks, Peter R. Orszag, director of the Congressional Budget Office, wrote that, in the current economic situation, there was a risk of "a self-reinforcing spiral (of less lending, lower house prices, more foreclosures, even less lending, and so on) that could further impair economic activity and potentially turn a mild recession into a long and deep recession."
In his view, there was only a moderate probability that this "self-reinforcing spiral" would take hold. The goal of the rebate checks, he said, would be to lower this probability "to an acceptable value." He thought that an economic stimulus bill might well make the difference.
When he signed the stimulus bill in February, President Bush called it a "booster shot for the economy." This analogy to immunization suggested that the rebate would reduce the chance of some economic disaster.
Has the tax rebate substantially reduced the probability of a downward spiral?
It is too soon to tell, because the Treasury only started to send out rebate checks in late April. Retail sales did rise in May. But the dreaded serious recession still seems very much a possibility. The unemployment rate shot up to 5.5 percent in May, from 5 percent. The Reuters/University of Michigan consumer sentiment index has fallen below the lowest levels of the last two recessions.
The theory supporting tax rebates was originally devised by John Maynard Keynes, one of the most influential economists of the last century. In 1931, during the Great Depression, he compared the economy to a stalled car. (The car, he said, had "magneto trouble," referring to a device once commonly used in automobiles to generate an electric spark for ignition.)
In Keynes's analogy, when an engine is running properly, each stroke of a piston gets the next piston ready to fire, which in turn gets another piston ready, in rapid sequence. Similarly, he said, when the economy is functioning properly, each time someone spends money, he provides income for another person, causing that person to spend money, and so on.
What was needed in the dysfunctional economy of the 1930s was a government stimulus to get things started again. Keynes referred to the additional rounds of expenditure, set off by the initial stimulus, as "repercussions," and to their total effect as the "multiplier."
But people who have studied such models find that these repercussions aren't powerful enough unless the initial stimulus is really large. Consider the Fair simulation model, a free Web site that embodies much of Keynes's theory and is offered by Professor Ray C. Fair of Yale. With the "U.S. Model" on this site, I increased transfers from government to households ("TRGH") by $100 billion in the second quarter of 2008. The results showed a $59 billion increase in 2008 gross domestic product. That is less than half of 1 percent of G.D.P.
The simulation also showed that this year's rebates would have further repercussions in 2009, bolstering G.D.P. by $36 billion that year. After 2009, the effects of this stimulus will just sputter out.
This is not going to mean the difference between prosperity and recession.
The Fair model quantifies the repercussions included in Keynes's theory. Why aren't they more powerful?
Part of the answer is in the slowness of people to spend extra money. Another is that some of the rebates will be spent on imports. That money will flow abroad, to stimulate other countries' economies, with little of their rounds of expenditures finding their way back home. Third, the domestic expenditures will tend to result in higher interest rates, both long and short, which should reduce investment and lower asset prices. When asset values decline, people tend to cut spending through a negative "wealth effect."
It is also possible that the effects of the rebate will be even smaller than the model predicts. Heightened anxiety about the economy might spur people to use the money to pay off debts and to save, rather than spend. And issuing tax rebates raises the government debt, at least initially, which might create angst for consumers who fear the possibility of higher taxes when the government repays the debt.
Fuzzy as this picture may seem, there is unfortunately even more uncertainty about the rebates' effects. Much of the recent dynamics of the economy are not captured in Keynes's theory, in Fair's Model, or in any conventional econometric model.
For example, these models have not taken account of the reasons for the peculiar lending dynamics in the subprime mortgage market, or of the state of financial institutions' balance sheets and the confidence that the public has in these institutions. Nor have they taken account of the vagaries of speculative asset markets, mistakes by securities rating agencies and the problems of bond insurers.
The economy is too complex to capture all these things in any single model. In trying to steer the economy, we are necessarily trying to steer something we don't properly understand.
We simply do not have the means to quantify all the issues related to the rebates. But the models we do have suggest that the overall effects of the rebates are modest at best.
The reality of the subprime situation, augmented by the energy crisis, at least suggests that we'd better get ready for another round of rebates. There is little talk of it now, but we should be putting in place another stimulus package like the current one, and stand ready for another after that, and another.
Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.