From the January 25, 2009 Sunday Times (London)
January 26, 2009
by Irwin Stelzer
Conservatives might not want to admit it, but it is just possible that President Barack Obama has cobbled together a coherent cure for the economy.
Let’s start with the stimulus package of some $825 billion. It’s a lot of money, but not much more than George Bush’s $700 billion Troubled Asset Relief Program and it will be spent over two or three years. Critics complain that stimulus spending will add to the already-swollen $1.2 trillion federal deficit willed to Obama by his predecessor. To which Obama will add about $400 billion a year. Query: what evidence is there that deficits of $1.6 trillion are more harmful during a recession than deficits of $1.2 trillion? None that I know of.
True, such deficits might make foreigners worry about holding on to dollars and US Treasury IOUs. That would trigger a bout of sales of Treasury bills and notes, and drive interest rates up to recovery-squashing levels. But so far, so good. The dollar has not followed the pound’s downward lunge for two simple reasons. First, a seeker-after-safety in this troubled world is not likely to find a safer haven than the American currency. Second, China and other holders of trillions of dollars and dollar-denominated assets are not eager to dump their holdings on the market, a move that would drive down the value of their remaining dollar assets.
Conservatives have jumped on new reports that about half of the planned $355 billion infrastructure spending will not occur until after the 2011 fiscal year starts on October 1, 2010, and therefore cannot create jobs in the here and now. True. But if – and this is a big if – the projects to be funded are likely to yield net returns to society for decades to come, they should be built whether part of a stimulus package or not.
The objection should not be to the construction of the projects, but to the assumption that they cannot be built by the private sector, given proper incentives. Toll roads, schools financed with vouchers, healthcare facilities selected by patients and paid for with healthcare vouchers – all are possible, but all are off the Obama radar screen.
Democrats are, in the end, Democrats and unlikely to be swayed by such as Harvard economics professor Robert Barro, who points out that it might be better to “emphasise reductions in marginal income-tax rates”. But the need for the projects themselves is in no way diminished if they get built next year, or the year after that, so long as they “pass muster from the perspective of cost-benefit analysis”, to use the test of Barro – and of Obama’s top economist, Larry Summers. Whether the Harvard crowd will be able to persuade congressional Democrats that they have it right is another matter.
In fact, there is something to be said for the postponement of the spending. The Great Depression was characterised by a modest recovery, followed by a relapse when monetary and fiscal policy were tightened, a so-called “W” pattern. The postponement of some of the stimulus spending to a time when the economy will be healing but still vulnerable to a relapse just might turn that “W” into a “V”, and provide the juice to keep the upswing moving along.
That leaves open the question of whether we are living in a fool’s paradise, with the dollar soon to plunge and interest rates to soar. Not likely, says Obama, who has a two-part – fiscal and monetary policy – strategy.
When the time comes to unwind the stimulus plan’s effect on budget deficits, and the Fed’s keep-the-presses-rolling monetary policy, Obama is counting, first, on striking a grand bargain between Democrats and Republicans to bring the potentially budget-busting healthcare and social-security (pension) entitlements programmes under control, and put the nation on a firm fiscal footing. Republicans will have to tolerate some tax increases, Democrats some entitlement cuts.
If Obama can wring such a bargain out of the rival parties, and reduce the level of spending now built into the entitlements system, he will have the cake he has eaten – deficit-increasing stimulus spending – followed by deficit-reducing entitlement reform.
Meanwhile, back at the Fed, either chairman Ben Bernanke or Larry Summers, by then probably the Fed chairman, will be implementing the exit strategy that Bernanke laid out in his speech at the London School of Economics. “Put out the fire first and then think about the fire code,” he said. The steps he has taken to use the Fed’s balance sheet to take on troubled assets, bail out banks and insurers – these put out the fire that would have consumed the financial system in America, and most probably in the world.
When the fire is out, and the economy chugging along, the excess liquidity can be siphoned off by selling Treasury bonds in return for cash, which will by that route be withdrawn from circulation. With a recovery under way, the banks will want to pay back the loans they have accepted under rather onerous terms. Also, money that has been lent to banks or used to prop up the commercial-paper market has been made available under short-term contracts. Allow them to expire, the extra cash disappears, inflation is slain. And if the timing is exquisitely right, the cash will be withdrawn gradually, in pace with the unfolding recovery.
There you have it. Spend now, and cut taxes now, and run deficits now. Build stuff that has a positive social value. Maintain faith in the currency by brokering a grand bargain to bring entitlement spending and therefore postrecession deficits under control. At the right time, call in all that extra cash that is sloshing around, thereby preventing inflation. And all will be well in this best of all possible worlds.
Perhaps. But if hyper-spending by government freezes out as much or more private-sector investment; if consumers, seeing tax increases in their future, rein in spending even more; if the government cannot impose its cost-benefit test on politically directed infrastructure spending – then Obama will not have kept his head when conservatives about him lost theirs.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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