The Fiscal Counterattack A change of perspective. Tom Nugent is Executive Vice President & Chief Investment Officer PlanMember Advisors, Inc. September 18, 2001, 8:00 a.m.

rior to September 11, 2001, the U.S. economy was slipping into recession. A dramatic easing in monetary policy had failed to provide the impetus that has traditionally reversed economic downturns. Technology gurus had labeled this expansion the “New Economy,” impervious to traditional cyclical economic factors. However, as 2001 began, this New Economy fell prey to overwhelming government policies that produced a substantial downturn in economic momentum. The major reasons for this turn of events were the interaction of tight monetary policy and the record budget surplus that was acting as a drag on the overall economy — a surplus that was made almost sacrosanct by many politicians in the nation’s capital. In fact, only until recently did the economic and financial community begin to come around to the reality that the contractionary effects of the surplus were the major culprit in undermining continued economic expansion. Note: One should be wary that, to the extent that the attack on America gets the blame for a weaker economy, the budget surplus, the true villain, may again escape blame, to return one day and again undermine another expansion. The ideas of “lockboxes,” and preserving the social security trust fund by curtailing or eliminating legislated tax cuts are now moot because of the terrorist attack. Fortunately, this change of perspective that commits the U.S. to eradicating global terrorism will also have positive economic implications. The Federal government’s initial commitment to disperse at least $40 billion to help the victims of the bombings and support the military response is a critical step in the right direction. However, it is actually a very small step in achieving the required fiscal effect necessary to reverse the current economic downturn. The erosion in the underpinnings of the global economy brought about by the bombing could easily offset the stimulative effect of that initial $40 billion in spending. Only if the government’s response is a seemingly massive program of fiscal stimulus, equivalent to at least 3% of gross domestic product, can this economic downturn be aborted. Given all of the current excess capacity in the economy, Congress must first decide how much it wishes to use for the war effort, and then aggressively cut taxes so that the private sector can use the rest. If the President and Congress don’t act quickly to attain this deficit by providing that combination of military spending and tax reduction, the same deficit will instead be achieved through rising unemployment compensation and falling revenues (tax collections). One effective way of providing this immediate shot-in-the-arm to restore consumer spending and confidence is a suspension of payroll taxes, at least until the economy is recovering. The resulting budget deficit will provide the basis for both the increased savings and spending that is desperately needed in the private sector. Such stimulus will reverse rising unemployment, boost consumer confidence, and enhance demand in the manufacturing sector. It will also temper prices, as payroll taxes are a substantial expense to business. And remember, sustained economic growth and investment are the only long-term solutions to provide adequate support for the elderly in the future. If the government fails to move quickly by either a cut in the payroll tax or some other broad confidence-builder of equal economic impact, the U.S. will not only be faced with fighting a war on terrorism, but also with a deepening global recession. America’s prosperity and growth are closely tied to a healthy, functioning world economy. The dramatic volatility in world financial markets in the aftermath of the terrorist attack attests to the reliance on a vibrant U.S. economy to maintain global economic growth. The latter has been severely compromised by the terrorist attack, as the cross-border movement of capital, goods and people has been brought to a virtual standstill. If the government does not move quickly to provide appropriate fiscal stimulus, the loss of morale due to a worsening recession could not only jeopardize the war effort itself, but also lead to dramatic political change in 2002. The “Attack on America” has changed the economic and political landscape. The U.S. economy will be called upon to provide the real goods and services necessary to conduct an unconventional war that has global implications. Hopefully, the government will provide the level of spending necessary to conduct an effective campaign against the terrorists while providing business and consumers with appropriate and immediate tax relief. Such a commitment will ensure a strong, healthy, vibrant economy we can rely on to support the demands of the new century.