The President's Stimulus Plan Misses the Mark

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On Monday, President Bush urged Congress to support his fiscal stimulus plan to give out billions of dollars in rebate checks in the hopes of staving off a recession. The Senate is currently debating who should receive those checks, and once those details are ironed out, the plan should have little trouble getting passed into law in some form.

Yet lost in the mad dash to take credit for giving a $600 handout to most people -- a handout that will cost the government at least $150 billion and add to already ballooning 2008 fiscal deficit predictions -- is debate on whether giving money to a large segment of the population is actually the best way to stimulate the economy. It's critical that legislators and other government officials think rationally about this. If lawmakers have to pass a stimulus plan, then it should be directed toward the areas of the economy that would be hurt most by an economic recession.

Right idea, wrong focus
The vast majority of the federal fiscal stimulus plan is aimed at getting relatively small checks into the hands of millions of Americans. Even assuming that many Americans spend this money -- which is far from certain -- the types of goods that I think consumers are most likely to buy with it are in areas of the economy that would be least affected by a recession, namely consumer nondurable goods.

Consumer nondurable goods include things like food, gasoline, and other items that get used up quickly. They're essential purchases for every family. And as a result, reductions in these expenditures during an average recession account for less than 12% of the total fall in overall GDP, according to Berkeley economist David Romer in his book Advanced Macroeconomics. Even if you throw in consumption services, such as visiting a spa or getting a haircut, the figure rises only to around 20%.

Put simply, if a recession is around the corner, you're not going to see a dramatic drop in spending on consumer nondurables. Companies like Safeway (NYSE: SWY) or personal-goods maker Kimberly-Clark (NYSE: KMB) haven't seen their shares hit by fears of a recession. So if I'm right and people will spend their rebate checks on consumer nondurables, the current fiscal stimulus plan is like a doctor treating someone for a broken arm when the patient has heart disease.

Where to put the money
On the other hand, according to Romer, investment spending is much more vulnerable to the ups and downs of the business cycle. Investment spending includes things like new-home construction and adding to business inventories. Romer states that in an average recession, reduced investment spending accounts for nearly three-quarters of the overall drop in GDP. Clearly, homebuilders like Pulte (NYSE: PHM) and Centex (NYSE: CTX) have already felt the brunt of the economic slowdown.

It's easier to cut everyone a $600 check than to figure out how to stimulate investment spending. And it's true that some spending will go toward consumer durable goods, which could help out sales for automakers like Ford (NYSE: F) or appliance hawkers like Sears (Nasdaq: SHLD). But it doesn't take a Harvard Ph.D. to know that $600 won't go too far toward a new truck, and with people increasingly reluctant to take on debt, most people will probably opt to spend their rebates on the things they need every day.

A better stimulus plan would focus on helping out the ailing investment-related sectors of the economy. Unfortunately, the current proposal resembles an old baseball player trying to prevent his decline by injecting himself with steroids. It may help in the short run, but the long-term adverse effects -- including a growing budget deficit -- will be much worse for the nation's economic health.