Prof. Roubini reports that the attendees of the recent American Economic Association Meetings finally take a recession in the U.S. as a given. Even Treasury Secretary Paulson has joined the recessionist club. The economic numbers point to a serious one. Recessionary tendencies in the rest of the world will likely follow, though probably not to the depth that is to be expected for the U.S.
What to do about this?
Earlier Roubini called for a serious cut of the central banks’ interest rates. But this would again increase the creation of money and risk another bubble. Argueing that too low interest rates have been the cause of the current credit mess and interest cuts would just revive and prolong it, Doug Nolan opposes such reflationary medicine. He sees four risks:
- Uncontrolled dollar devaluing and a possible currency market dislocation
- Geopolitical risks caused by inflation of raw goods (hungry people revolting against their governments)
- More destabilizing money flow to the BRIC (Brasil, Russia, India, China) countries
- Much higher consumer price inflation in the U.S.
While the first three problems are only indirectly effecting the U.S. public, the fourth one is a serious worry even for isolationists. Inflation is already at a multi decade high (Gold today broke another record).
Besides interest rate cuts by the central bank there are other tools available.
The economic standard approach to lessen the effects of a recession is Keynesian deficit spending:
an increase in government purchases creates a market for business output, creating income and encouraging increases in consumer spending, which creates further increases in the demand for business output. (This is the multiplier effect). This raises the real gross domestic product (GDP) and the employment of labor, all else constant lowering the unemployment rate. (…) Cutting personal taxes and/or raising transfer payments can have similar expansionary effects, though most economists would say that such policies have weaker effects on, which method has a better stimulative economic effect is a matter of debate.
The economic discussion in the U.S. now evolves around the last sentence. Should taxes be lowered or should the government spend more on domestic programs?
The Wall Street supply sider side of the discussion and the Bush administration predictably call for further tax cuts. (Times are good, we can cut taxes, times are bad we must cut taxes.)
But as Jared Bernstein points out, a buck spend on tax cuts is not the same than a buck spend elsewhere:
For example, analysis of this point has found that a dollar of revenue sacrificed for a dividend or capital gains tax cut yields a measly [GDP increase of] nine cents.
You get a much better bang-for-the-stimulative-buck from direct spending. A dollar spent shoring up Unemployment Insurance yields $1.73; a dollar spent on fiscal relief to the states yields $1.24. This last idea—ratcheting up state grants from the Feds—is particularly important right now, since many state and city coffers are coming up short due to the local revenue impacts of the housing meltdown.
Dean Baker argues to use a stimulus package to futher green energy and green consumption behaviour. Use the stimulus package to build subsidized wind energy mills and to subsidize public transportation.
The amount talked about (sub.req.) is $75-$100 billion of stimulus package per year over several years, financed by further public debt.
But here’s the problem. Keynes concept is based on saving in good times to be able to spend in bad times. The U.S. consumers, as well as the government, has spend far beyond their income throughout the last years. The fed had lowered the interest rate too far and has already created significant inflation. There is not much, if any, room left to now use the standard Keynesian deficit spending medicine without serious negative sideeffects. Exactly the problems Noland points to: (much) higher (global) inflation and further uncontrolled devaluation of the U.S. dollar.
In a just published new piece Roubini comes to the same conclusion:
We did indeed waste all our macro policy bullets in 2001-2004 in “the best recovery that money can buy” and we are now left with relatively limited room for monetary and fiscal policy stimulus. This is one of the main reasons why the 2008 recession will be more severe and protracted than the mild 2001 recession.
In my view any stimulus package to lessen the recession effects has to be within these boundaries:
- The money needs to be spend on local infrastructure investment to decrease unemployment, not to induce larger consumption.
- Public debt is already to high. Further borrowing has serious side effects like higher effective interest rates, a dollar dump and higher inflation. The spending must thereby be financed by tax increases for very high incomes (which would also remove the moral hazard that led to irresponsible behavior of bank CEOs and others.)
Even if such a stimulus is enacted one has to keep in mind that:
- the current recession will be several years long (the housing slump will take years to heal),
- it is needed to cure the U.S. current account deficit and to renew savings,
- any stimulus will not be able to avert the recession – only to lessen its effects.
In the current political constellation it is doubtful that any serious measure will be taken during 2008. The effects of the recession, much higher unemployment and a significant drop in GDP, will thereby become worse.
As the economic mess will turn out to be the primary matter in 2008, it will interesting to see what recipies the candidates will present to heal the economy. Paul and Edwards are the candidates that have the most radical positions here. They could use the trouble to their advantage.