Recession at the Gates

There's still time for lower rates and tax rebates to help the economy.

By Anne Kates Smith, Senior Associate Editor

From Kiplinger's Personal Finance magazine, April 2008

The debate is the same, whether at the boardroom table or the kitchen table: Are we headed for a recession? Already in one? And if not, is there anything we can do to avoid one?

The answers to the first two questions depend on how successfully policymakers and politicians address the third one. A Federal Reserve Board that remains aggressive about cutting rates may be able to make up for coming late to the game. And if politicians get some spending money into consumers' pockets and companies' coffers quickly enough, a recession that seems a sure thing to the majority of Americans may yet be averted. If not, it may at least be shorter and milder than it might have been.

The difference between an "official" recession (defined as a significant drop in economic activity for several months) and a painfully slow -- but still positive -- economy is somewhat semantic. A net loss of 17,000 jobs in January means no more paychecks for some of us. Hard times have also arrived for restaurateurs, retailers, bankers and other executives who are reporting the largest decline in service-sector activity in five years. By one survey, layoffs will be up 37% this year over last year.

"Things are definitely getting dicier," says Lakshman Achuthan, managing director of the Economic Cycle Research Institute. He likens the economy to a large stone column that is starting to lean after being pounded by higher oil prices, lower home prices and a nasty credit crunch. If it falls, you've got a recession.

But pushing back now and applying just the right pressure could right the column again. That was the goal when the Fed lopped 1.25 percentage points off the federal funds rate in January. More cuts will likely lower the rate that banks charge each other for overnight loans to between 2% and 2.5% by summer, down from 3% recently.

The problem: Lower rates may not be as effective as hoped because housing, the most rate-sensitive sector of the economy, won't respond fully until the mess in the mortgage-backed securities market is straightened out.

That's why an economic-stimulus package from Washington is a more potent force. The one hammered out by Congress in February is a powerful mix of tax rebates, incentives for business investment and measures to kick-start the mortgage market. At a cost approaching $170 billion, the package would put checks ranging from $300 to $1,200 in taxpayers' pockets this spring. (Calculate your own rebate check here.) It would also help mortgage borrowers by temporarily increasing the size of loans backed by government insurance and by Fannie Mae or Freddie Mac (see The Race is On to Refinance).

Will it be enough -- and soon enough -- to stave off recession? The official answer is months away. But the effort will take some of the teeth out of any downturn headed our way. The stimulus package could add 1.5 percentage points to gross domestic product growth by the second half of '08, figures Moody's Economy.com, assuming half the windfall is spent by year's end. That's enough to put 700,000 more workers on payrolls by mid 2009 than would otherwise be possible. We expect GDP growth of 1.5% for 2008.

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