A.G.EDWARDS & SONS,INC.
ECONOMIC RESEARCH
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ECONOMIC TRENDS
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THE CLINTON PLAN
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President Clinton's new economic plan is being well received by the
financial markets. The plan is a blend of several policies - a stimulus
program to help the economy and a deficit reduction package of spending
cuts and tax increases. The plan is a dramatic departure from the status
quo, particularly in the size of the tax increases. Consequently,
interest rates have fallen more than expected. However, the timing of
the policies needs to be considered in order to assess the immediate and
long-term impacts. Over the short run, the plan will increase spending
on top of the already developing economic expansion. Only later will
spending be cut and taxes increased. The net effect should be to boost
economic activity this year, and once the economy gets rolling, reduce
the deficit.
TAXES AND THE ECONOMY
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If the Clinton plan is passed with few alterations, taxes will increase
for almost everyone. The top tax bracket will increase on high incomes
and an energy tax will add to the cost of driving, heating and lighting
most homes and businesses. Those with the lowest incomes will receive a
new tax credit to pay for the added energy expenses. The income tax
would go into effect this year, but the administration does not plan to
penalize taxpayers for underwithholding. Therefore, most of the tax
increases are not expected to be paid until next year. In addition, the
energy taxes are not scheduled to begin until early 1994. Thus taxes
will not increase significantly this year. Some of the expected tax
increases will change spending decisions relatively soon, but since most
of the taxes will not reduce spendable income until next year, the
economy as a whole should not suffer for some time. In addition,
empirical evidence shows that the economy may not feel the full impact of
tax changes for up to six quarters. Therefore, the economy should be able
to sustain average and occasional above average growth this year and next;
but by 1995, the rate of economic growth could slow to below average.
CONSUMER CONFIDENCE AND FINANCES
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Economic growth during the second half of 1992 was above average, and the
number of unemployed workers declined. The economic improvement and the
change in administration lifted consumer confidence. However, recent talk
of tax increases and sacrifice has caused confidence to slip again.
Fortunately, the latest decline in sentiment is not due to deteriorating
financial conditions, but due to the uncertain impact of changing policies.
In fact, consumers have greatly improved their finances, and as of the
fourth quarter, the rates of home mortgage delinquencies has dropped to its
lowest level since 1974. Confidence may be down, but this is not stopping
many individuals from taking advantage of the drop in interest rates.
A BOOM IN HOUSING?
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Mortgage rates have recently dropped to their lowest level in 20 years, and
according to the Mortgage Bankers Association, mortgage applications have
skyrocketed. Applications for new purchases are at a new cyclical high, and
applications for refinancing are strong. Home sales are actually starting
to boom in some parts of the country. In addition, the last two times
refinancing hit the current level, economic growth increased to an above
average rate shortly thereafter.
DECLINING RATES IN A GROWING ECONOMY
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The current decline in interest rates on top of the developing expansion is
very unusual. It reflects the high degree of liquidity in the economy, and
the continued willingness of consumers and businesses to reduce debt and
improve their finances. This development should be very good for the
economy. In fact, history shows that the longer interest rates decline
after the economy begins to recover from the recession, the longer the
economic expansion is likely to be. Of course, the Clinton tax increases
will hurt the economy in a couple of years, but the financial restructuring
now underway will make the economy better able to handle a tax increase.
FINALLY - JOBS,JOBS,JOBS
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Initial jobless claims have declined over the last several months, and the
Labor Department's survey of households has recorded sizable increases in
employment. However, the survey of employers did not register much job
growth until February. According to the latter survey, total nonfarm
payrolls finally posted a large increase with payrolls rising by 365,000
last month, the biggest gain since 1989. This large increase was confirmed
by a similar gain of 380,000 jobs in the household survey. However, the
two surveys still show differing employment levels. According to the
employer survey, nonfarm payrolls remain depressed, but according to the
household survey, total employment hit a new record high in February.
FED POLICY REMAINS ACCOMMODATIVE
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The Federal Reserve continues to hold short-term interest rates at low
levels, and there is some speculation that the Fed will lower interest
rates again if the economy suffers as a result of the deficit reduction
plan. But, this is not likely in the short run. With the economy finally
creating more jobs, the Clinton stimulus plan may not be needed. Indeed,
if the government increases spending, while consumers and businesses are
rushing to take advantage of the current low interest rates, bottlenecks
could develop in the economy and inflation could be higher than generally
expected. Some commodity prices have already started to rise, and the next
move by the Fed could be to increase interest rates later this year.
INTEREST RATE OUTLOOK IS MIXED
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Further interest rate declines are possible this winter due to the
projected deficit reductions and the expected negative economic impact of
the Clinton tax increases. However, the decline in the deficit and the
possible slowdown in growth will not occur for a couple of years. In the
meantime, the economy should strengthen. Therefore, after the initial
euphoria fades, economic growth should accelerate and interest rates could
increase again.
CONCLUSIONS:
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Further interest rate declines are possible this winter, but as the
economy strengthens, some inflationary pressures could emerge. Thus the
current decline in rates is likely to be followed by a rebound in rates
later this year. Long-term Treasury rates could decline to near 6.5% as
long as the euphoria over the Clinton plan continues. However, if the
administration goes through with the stimulus plan, rates could return to
7% or more by summer.
Ray Worseck March 8, 1993
Chief Economist and Manager
Gary Thayer
Senior Economist
This information is obtained from internal and external research sources
considered to be reliable, but is not necessarily complete and its
accuracy is not guaranteed by A.G.Edwards & Sons, Inc. Any opinions
expressed are subject to change without notice. Neither the information
nor any opinion expressed constitutes a solicitation for the purchase or
sale of any security referred to herein.