US fiscal and monetary policy, keys to global recovery
Published:Friday | August 6, 2010 | 12:00 AM
Last Thursday, James Bullard, president of the Federal Reserve Bank of St Louis, came out with a view that's gaining ground among members of the Federal Reserve Board.
He suggested that the US Fed's policies risk causing the economy to fall into a "Japanese-style deflationary outcome within the next several years".
Bullard, as several others until now, was most concerned with avoiding inflation.
Beginning in May 2008, the Fed consistently said it would maintain interest rates "exceptionally low" for an "extended period".
Such Fed-speak, once decoded, means the critical federal funds rate will remain at its current level, targeting 0-0.25 per cent, through to 2011.
Recall that in 2007, the Fed had lowered its benchmark short-term interest rate to zero while feeding US$2 trillion into the economy by way of emergency loans, purchases of mortgage bonds and government debt.
One key impact of this policy mix was, of course, to keep the housing bubble going and Wall Street afloat until September 2008. Phased out since March 2010, there are hints at resuming such purchases.Will this solve the problem of unemployment and the threat of Japanese-style deflation and lost decade?
This is unlikely, precisely because Wall Street banks have been allowed or enabled to keep toxic assets on their books. Some that would have failed have been bailed out in ways that allow them to continue with leverage they will reduce in 'dribs and drabs' over many months - precisely the Japanese 'lost decade' scenario.
The US$789 billion of TARP funds is one thing but trillions from the Fed at zero interest is entirely another.
No consistency
As if this is not all, the politics of a Republican tax-cutting religion, showing no consistency in their stance towards budget deficits and support for assistance to small business as a crucial provider of jobs in the economy, may force the Obama administration in a midterm election year to leave the Bush tax cuts in place for the wealthiest two per cent of the population at a cost of further trillions.
David Stockman, director of the Office of Management and Budget under President Ronald Reagan, in a July 31, 2010 New York Times article titled 'Four Deformations of the Apocalypse', was almost caustic in attacking the current Republican position.
Should there have been a "Chapter 11 for politicians," Stockman wrote, "the Republican push to extend the unaffordable Bush tax cuts would amount to a bankruptcy filing. The nation's public debt - if honestly reckoned to include municipal bonds and the $7 trillion of new deficits baked into the cake through 2015 - will soon reach $18 trillion. That's a Greece-scale 120 per cent of gross domestic product, and fairly screams out for austerity and sacrifice."
But this is not all. He goes on to point out that in 1981, traditional Republicans proposed tax cuts, matched by spending cuts.
The Reagan administration's fiscal blueprint, Stockman laments, was "no match for the primordial forces - the welfare state and the warfare state - that drive the federal spending machine."
The neocons, he says, "soon were pushing the military budget skyward. And the Republicans on Capitol Hill who were supposed to cut spending exempted from the knife most of the domestic budget: entitlements, farm subsidies, education, water projects. But in the end it was a new cadre of ideological tax-cutters who killed the Republicans' fiscal religion."
This is a resounding indictment from a former Republican insider.
Thing is, it is all absolutely true.
From the day in 1971 that Milton Friedman persuaded President Nixon to default "on American obligations under the 1944 Bretton Woods agreement to balance our accounts with the world. Now, since we have lived beyond our means as a nation for nearly 40 years, our cumulative current-account deficit - the combined shortfall on our trade in goods, services and income - has reached nearly US$8 trillion," Stockman writes. "That's borrowed prosperity on an epic scale."
Fundamental change
On the domestic front, he laments another fundamental change in the American economy: that there "has been the extraordinary growth of our public debt. In 1970 it was just 40 per cent of gross domestic product, or about US$425 billion. When it reaches US$18 trillion, it will be 40 times greater than in 1970. This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party's embrace, about three decades ago, of the insidious doctrine that deficits don't matter if they result from tax cuts."
US business investment and consumption are drivers of the world economy. So long as China and others are willing to take Uncle Sam's debt at such low interest rates - and this is likely to continue into the foreseeable future - the discipline to be derived from balance of payments performance will continue to be optional.
Herein lies the contradiction. The US economy must grow if the world economy is to grow.
If Republicans, to win the midterm election, succeed in derailing stimulus policies meant to reduce unemployment, pushing the economy towards double-dip recession, while the UK coalition government imposes immediate deep austerity measures, as they seem set to do, double dip, lost decade, prolonged US unemployment - all of the above appear possible - and the attendant fallout upon the Caribbean then begin to seem inevitable.
We must prepare ourselves to handle these developments. Chinese investment in our productive capacity is to be welcomed.
We need to ensure that it comes with as few string attachments on the package as possible and that it fits into our developmental plans.
Particularly, our policies must so dovetail with these that they early impact on youth unemployment, food production and water resource enhancement.
Relevant plans of Caricom, while we're at it, might be dusted off and implemented. This is by no means too much to require from those responsible for policy.