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Legacy of debt gives fiscal stimulus bad name

Legacy of debt gives fiscal stimulus bad name
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First Published: Fri, Jun 05 2009. 10 06 PM IST

Updated: Fri, Jun 05 2009. 10 06 PM IST
By the time the US government unveiled its public-private investment partnership in March, the toxic loans and securities clogging bank balance sheets had become legacy assets.
What if deficit hawks took the same tack and marketed the $787 billion (Rs3.7 trillion now) fiscal stimulus as legacy debt?
The $787 billion the US treasury will be borrowing or confiscating from you (Americans) via taxation will saddle future generations with a legacy of debt, the press release might read. Your children and grandchildren can look forward to higher taxes, a lower standard of living and minimal government support in their old age.
Maybe the public would baulk. And maybe some member of Congress would be bold enough to sponsor a measure to call off the still-uncommitted expenditures.
After all, the economy appears to be recovering without fiscal stimulus. The rate of decline in real gross domestic product (GDP) has slowed from an average 6% in the fourth quarter of last year and first quarter of 2009. Real GDP is expected to fall 1.9% in the current quarter, according to the median forecast of 61 economists in a Bloomberg survey from early May.
And that’s before any real money gets spent. So far, $36.7 billion has been distributed via various government agencies, according to Recovery.gov, the website that tracks where your tax dollars are going. That’s 7.4% of the $499 billion of outlays ($288 billion of the $787 billion is tax relief) and 29% of the funds that have been committed to a purpose or a project.
Patient, heal thyself
Tax relief comes in the form of larger monthly pay cheques for workers and tax credits that are encouraging activity now even though the benefit is in the future. Still, it’s a trickle, not a waterfall.
So if fiscal stimulus can’t take credit for the improvement in the economy, what can? The answer is a combination of monetary policy and self-healing (an economy’s natural tendency is to grow).
The US Federal Reserve has thrown the kitchen sink at the economy, using traditional and non-traditional means to provide liquidity and credit when the banking system wasn’t up to the task.
Even before the Fed lowered the overnight interbank lending rate to 0-0.25% in December, the central bank was already ministering to markets and institutions outside its normal discount window customers, otherwise known as depository institutions. It was supporting the commercial paper market; had committed to purchase mortgage-backed securities and agency debt; had agreed to finance investor purchases of asset-backed securities; and had lent support to specific institutions, taking on some of Bear Stearns Companies Inc.’s toxic, I mean, legacy, assets in March 2008 and bailing out American International Group Inc. in September.
That’s the beauty of monetary policy. It can be implemented instantaneously. The Fed’s challenge is to be as quick on the return trip.
The problem with fiscal stimulus, aside from the fact that it’s a misnomer, is that it arrives too late.
At least that was the standard criticism prior to the enactment of the $787 billion American Reinvestment and Recovery Act of 2009 in February. The government’s tax and spending policies require the approval of a majority of the 100 senators and 435 members of the house of representatives. And as we know, these 535 individuals sometimes confuse the people’s business with their own: getting re-elected.
Preferred stimuli
This time around, a new president with solid majorities in both houses of Congress was able to saddle future generations with trillions of dollars of debt less than a month after he took office. The congressional budget office projects the debt-to-GDP ratio rising to 70% in 2011, the highest since the early 1950s, when the US was winding down the war effort.
If you believe, as I do, that monetary policy is the more potent of the stimuli, that fiscal stimulus just transfers spending from tomorrow to today and from the private sector to the government, with no net long-term gain, then maybe it’s time to stand up for the next generation.
Besides, where is it written that the ill effects of years of over-consumption and under-saving have to be repaired in a year? Instant gratification means future deprivation.
Word choice
Fed chairman Ben Bernanke used part of his 3 June testimony to the house budget committee to warn of the consequences of unchecked spending, even in the face of recession and financial instability.
Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth, he said.
If it takes a marketing gimmick—labelling fiscal stimulus a legacy of debt—to convey the message to the public and Congress, so be it.
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First Published: Fri, Jun 05 2009. 10 06 PM IST