Econowatch

Forget what economists have told you about how stimulus programs are supposed to function during a recession. You can learn a lot more from watching a master illusionist at work.

Take America’s US$8,000 tax credit for first-time homebuyers. Like any stimulus measure meant to jolt the economy out of recession, the tax credit was always more about smoke and mirrors than economic theory. When Washington created the program eight months ago, its aim was to conjure the illusion of stability in the housing market. Until the free fall in house prices could be halted, a broader economic recovery could never take hold.

So Uncle Sam began funnelling US$14 billion to buyers. The program has taken lots of knocks from critics along the way. An audit found thousands of cases of potential fraud and abuse. One house was even bought in the name of a four-year-old. Still, because of the sleight of hand, confidence materialized where none had existed before. In September, home sales rose 9.4 per cent to an annual rate of 5.57 million, the highest level since 2007. Prices have also registered three straight month-over-month increases. Low interest rates played a part, of course. But economists attribute most of the improvement to the tax credit.

Here’s where it all gets tricky. The tax credit is due to expire at the end of November. Lawmakers in Washington must now decide whether to extend it, gradually phase it out, or pull the plug entirely. The stakes are huge. After officials scrapped cash-for-clunkers, a scheme to encourage Americans to buy cars and trucks, automobile sales plunged 23 per cent the next month. Eric Sprott, the Toronto hedge fund manager, predicts that if the tax credit isn’t extended, the volume of home sales will plunge 30 per cent in January. So it’s no surprise the real estate industry in America is lobbying hard for another US$16 billion to carry the program through to next June.

But at some point the illusion has to end and reality must take over. The U.S. government can’t indefinitely prop up the housing market. How will the big reveal play out? And will the American audience stay in their seats, or make a mad dash for the exits? The next moves that Washington makes could well be the most important since the fragile recovery began last spring. The wonder of it all won’t be that billions of dollars could create the illusion of stability, but whether that stability will hold once the strings are cut.

GRAPH OF THE WEEK: Rebuilding the market
Balance is returning to the U.S. housing market, as sales increase and the glut of unsold homes shrinks. But sales are being driven by a US$8,000 tax incentive for first-time buyers, set to expire next month. Without it, can the rosy trend continue?

GOOD NEWS

Growing up
The Bank of Canada upped its outlook for the country, and now expects the economy to grow 3.3 per cent this quarter, up from its previous forecast of three per cent. The bank credited consumer spending for the country’s improving fortunes.

Retail rebound
Speaking of consumers, retail sales in Canada rose 0.8 per cent in August from the previous month. The gains largely came from higher gasoline prices and automobile sales. Sales weren’t spread evenly across the country, though. The Atlantic provinces fared best, while Alberta saw sales plunge 9.4 per cent.

Off the dole
Happy consumers need jobs. Fortunately, the number of Canadians collecting unemployment insurance fell 2.4 per cent in August, from the month before. It was the second straight decline.

Lead the way
Economists cheered as the U.S. Conference Board’s index of leading indicators blew through their expectations in September. The index, a barometer of where the economy will be in three to six months, rose one per cent, more than the 0.8 per cent economists were looking for. The index got a big boost from rising consumer expectations.