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Business News/ Opinion / Online-views/  Cost of stimulus can lead to deeper crisis
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Cost of stimulus can lead to deeper crisis

Cost of stimulus can lead to deeper crisis

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Record US fiscal and monetary stimuli have caused some credit market easing. In the short term, the economy and stock market may also bounce. But the cost of the stimulus could later cause treasury market stress, a lightning-bolt-shaped recession and stocks below November’s lows.

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Credit conditions have now eased considerably; the spread between the two short-term rates is only modestly above historic levels. Thus, business activity requiring credit might rebound smartly, if banks can become comfortable with borrowers’ credit prospects.

Moreover, the oil price decline from its $147 peak (Rs7,144 today) to around half 2007’s level has added nearly 2% to consumer incomes, bringing the possibility of stronger retail spending. Economic numbers released from March 2009 onwards, given the normal data lag, should demonstrate new strength. That would boost the stock market.

Longer term, economic reality will reassert itself. If credit conditions return nearly to normal, the rapid recent money supply expansion, which shows no sign of near-term reversal, will over 12-18 months work through to prices.

The 2009 Federal budget deficit, nearly 10% of gross domestic product, is bound sometime to cause financing difficulties in the treasury market. Should those difficulties combine with rising inflation, treasury bond prices could collapse, while a “buyers’ strike" complicates new long-term government financing.

In that event, US economic conditions would once again turn sharply downwards, with subsequent recovery very difficult since fiscal and monetary stimuli would be tapped out. Those predicting a W-shaped recession may be too optimistic; its true shape may be a lightning-bolt, with a much more decisive second downward leg.

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Published: 13 Jan 2009, 09:07 PM IST
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