The science magazine Nature reported in its August 2007 issue that a comatose patient has been brought back to consciousness by doctors who implanted electrodes deep inside his brain. The method, called deep-brain electrical stimulation (DBS), has successfully roused communication, complex movement and eating ability in the 38-year-old American patient.
Policymakers in the US are attempting no less remarkable a feat with the US economy. Their tools, however, are old and blunt — monetary stimulus and old-fashioned Keynesian fiscal policy.
Will the comatose US economy wake up?
The case has several complications. The central nervous system, i.e., the credit market, has almost completely switched off. Indicators of whether nerves are twitching, such as credit default swap spreads, are actually evidence of contra-indication. There is some suggestion that certain parts of the anatomy are more deeply affected than the rest — the industrial mid-west and the “housing bubble” states of California, Nevada, Arizona and Florida. While the general category of illness is well known to some as acute “lackofsavingsitis”, this particular version of the illness, with its unique complications, is less well known and understood.
This patient was revived once before in 2001-02 with a very strong shot of monetary easing down to 1% in the Federal funds rate. This known “cure” is likely to result in its overuse and consequently its eventual inability to produce. Doctors fret that that time is here.
Since the patient is rich, there are teams of doctors called upon to give their professional opinion. The first debate among the doctors attending to this economic patient is what the drug cocktail should be. Exactly what proportion monetary and what percentage fiscal?
In the US, the current mix is a 3% rate reduction combined with approximately 1% of GDP fiscal shot. Keep the saline drip going, they say, using it as short form for the recently announced term auction facility (TAF).
For what it is worth, this writer/doctor believes that the brunt of the counterattack has to be shouldered by fiscal policy. For lasting effect, fiscal policy must match or exceed the largest projects that America has seen and will likely dwarf the massive highways project under president Eisenhower in the 1950s.
Of course, there is one big difference between real-life patients and an economy.
The prognosis for an economic patient depends, in some significant part, on the confidence of participants in that economy. It is almost as if what matters is not how good or bad you feel, but how those observing you feel!
This confidence will come about when participants believe that a competent set of doctors is going about the recovery process in a credible way. Again here, there is a contra- indication.
Even if you ignore their present lame-duck status, the lead fiscal doctors will all have to change with the US presidential election in November. And, for the first time last month, Sudip Reddy writing in The Wall Street Journal (14 February 2008) raised the unmentionable thought—“Should Bernanke be replaced?”
So, is the patient’s case cooked?
Despite the tremendous odds against the patient reviving, my bet is for recovery. The recognition that the patient is sick and requires treatment — fast, strong and furious — by itself improves the odds.
The ability to use old tools but new techniques — TAF, mortgages as collateral for the US Federal Reserve, opening the window to primary dealers, etc. — improves it some more. The big financial institution (Bear Stearns) that was on the brink of going under has been rescued — think of it as a new kidney put in a split second before acute renal failure. It doesn’t work this way with humans — but the point of severe bearishness (like we had last week) is most usually the point of inflection for the stock markets.
Not totally normal yet perhaps, but enough to say the patient’s out of a coma and on the road to recovery.
Postscript: Indian doctors, coming from an ancient school of medicine suggest that permanent recovery will require giving up alcohol and fatty foods (low savings, twin deficits), starting yoga (productivity and innovation) and balancing it with a bit of precision surgery (rating agencies, bond insurers, undercapitalized and overleveraged banks and funds).
These are personal views. Comment at firstname.lastname@example.org