þ#&]%%+f¥ ! )19AI ÿ A.G.EDWARDS & SONS,INC. ECONOMIC RESEARCH ---------------------- ECONOMIC TRENDS ---------------------- THE CLINTON PLAN ---------------- 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 --------------------- 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 -------------------------------- 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? ------------------ 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 ------------------------------------ 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 ------------------------ 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 -------------------------------- 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 ------------------------------ 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: ------------ 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.