Wednesday, December 3, 2008

Spending is needed, but to what end?

Earlier today I wrote an article that I simply had to take off of the web. I recoiled when I read this article by Martin Wolf that led me to this article at the Financial Times. Congress is certainly going to mess this up.

Originally, I stated that the government should spend (as it is surely going to do) rather than cut taxes because consumers saving is rising and the marginal propensity to consume is falling. Simple Keynesian multipliers suggest that a spending stimulus would insure the biggest bang for the taxpayer’s buck.

I apologize – that post made me very uncomfortable and I had to take it off the net because I simply don’t trust Congress not to overdo it.

To be sure, Bernanke cannot do it alone. When the central bank faces a liquidity trap – like the U.S. Fed is facing right now – fiscal policy is the country’s best hope for a government-bought expansion. But how much should the bill cost taxpayers?

On October 15, Democratic leaders said $300 billion

On December 1, Pelosi says $500 billion

And today, I find an article from the Financial Times, dated on November 24, that the fiscal package could cost anywhere between $500 billion and $1,000 billion (why don’t they just say $1 trillion?).

One has to wonder if policy makers really have a clue what they are proposing. When exactly did we move away from a world of $billions to a world of $trillions?

The budget deficit is already estimated to reach $1 trillion (yes, $1,000,000,000,000) in 2009, and that doesn’t include the $300 billion, no $500 billion, no $1 trillion stimulus plan.

Yes, a fiscal stimulus is needed. This recession has got some teeth on it, and since the banking sector is hoarding cash, monetary policy is impotent. But when is it simply too much? I guess that a counterfactual is in order, but I just don't have one besides the Great Depression. I suspect, though, that Congress is going to overdo it.

Rebecca Wilder


  1. Sad to say it, but that's chump change in this environment. The pledges are already in excess of $8.5 Trillion last time I checked, with no slowdown in sight the bailout appears to be growing faster than the pace of the entire US economy.

    People need to stop looking at inflation vs deflation and start thinking about currency collapse. It's simply not possible to assume this level of debt/risk.

  2. A different perspective: In Japan, the increase in government borrowing matched the decline in private borrowing in order to prevent a contraction in total credit.

    I'm not sure what private debt (bank and securitized credit) is in the U.S., but is it possible we could see a 10% decline in this recession? If so, what would it imply for government borrowing needs using the Japan example?

  3. Big Governmentalism and Collectivism is the problem.

    Adding more of the problem to a problem does not conquer the problem.

    Politicians must cut the military by 50% and the rest by 95%.

    Next, Politicians must end Collectivism by ending Income Taxation and Re-distribution (bailouts, subsidy, government contracts, welfare).

    Ending all income taxation is the best "Fiscal Stimulus" action available.

  4. Hi Rebecca "This recession has got some teeth on it"

    Is this not an understatement with plenty of teeth on it?! Given the global dimension, things look as dire as they can be, dont they? If the fiscal stimulus is too big, wont it almost be a relief to get rocketing interest rates (even if belatedly) and a more familiar problem to deal with?

  5. Rebecca - I appreciate your blog and informed analysis, esp. on the 'printing' issues. But you training was anything like mine, our formal training was largely confined to Keynesian and post-Keynesian dogma with a bit of monetarism thrown in.

    Back in the 30s, the debt carrying capacity of the entire society was still largely unexploited. So Keynesian fiscal policy borrowed from future income that was largely unencumbered.

    I don't think we have that luxury today. Regretably, I believe the Austrian/Schumpeterian/von Mises view of the world is much more apropos and prescribes a very different policy and more sobering outlook.

    Coupled with the hyperbolic trajectories that are the focus of Chris Martenson's crashcourse, economists need to look much further outside the box imho on what are real options are.

  6. The Wolf article RW links is subscriber only. The FT actually allows backdoors to those who Google (Shhhh! The FT knows this, but they don't want the hoi polloi who can afford the ticket seeing the concert from the side fence)

    Here is a url that should get you directly to the article. If not, just Google for the title, and the Google ticket will get you in:

    If the above doesn't work, then enter: "Global imbalances threaten the survival of liberal trade" into Google News

  7. Here is a direct link to the Wolf article RW references:

    Thank MSN for buying the ticket!

    It is a must-read.

  8. We seem to be hung up on comparisons to the 30's. The population's view of their lives and the world was SO different. They only had what they could pay for up front. So, we may take some lessons from the actions of those government entities and banks reactions and go from there. There are too many noughts in the figures to make sense - again, monopoly money and the ones spending it don't really care as long as they do something.

  9. Any deficit, by definition, creates a demand for loan-funds. The larger the deficit, the higher interest rates will be, or the less they will fall.

    Any given deficit should be evaluated in terms of: (1) the size of the deficit in the context of the size of future deficits, and the accumulated debt relative to the means and costs of financing the whole: (2) how the deficit is financed: (a) from savings or (b) commercial bank credit, i.e., newly created money; and (3) the purpose for which the deficits are incurred.

    Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security for now is not include in the above list since only a very small proportion of social security benefits are financed from non-social security taxes.

    From an economic standpoint, only interest is “untouchable”.

    If current projections of Federal Deficits materialize in this, and the next few years, interest rates (both long and short-term) will be driven up sharply by the increased demand for loan funds.

    I.e., any recovery in the economy will present a “Catch 22” situation. An upturn in the economy will add increased private demand for loan funds to the insatiable demands of the Federal Government. The consequent rise in interest rates will effectively abort any recovery.

    Raising taxes to accomplish a reduction in the deficit would be counter-productive. Most of this debt is short-term. Combine this with the factor with the constant roll-over of some of the long-term debt and it becomes obvious that the burden of higher interest rates will be compounded.

    The burden becomes a function of the major portion of the debt, not just the current deficits. The burden, in fact, becomes exponential. In other words, if the trend is not stopped, the debt inevitably has to be repudiated.

    Only direct controls can cope with this problem. Which is just another way of saying that we will, to a greater or less extent, have to resort to a “command” economy to cope with the debt problems we have so cavalierly created.

  10. Those who are wont to minimize the ill effects of the deficit are prone to compare the size of the deficit with nominal GDP, as if the volume of nominal GDP were independent of the size of the deficit.

    Unprecedentedly large deficits “absorb” a disproportionately large share of nominal GDP.

    Present deficits are unprecedented no matter how measured, and the past gives us no reliable guide to the future effects of deficit financing, beneficial or otherwise.

    To appraise the effect of the federal budget deficit on interest rates, it is necessary to compare the deficit, not to GDP, but to the volume of CURRENT SAVINGS made available to the credit markets.

    The current deficit is absorbing about 24% of gross savings (last calculation).

    The more alarming aspect of the deficits is not the effect on interest rates but the effect of high interest rates on the level of taxable income and the volume of taxes required to serve a cumulative debt now exceeding $9.7 trillion.

    Both high interest rates and high taxes induce stagflation, thus eroding the tax base and increasing the volume of futures deficits.

  11. Banks don't loan out "savings".

    Get the money creating "banks" out of the savings business.

    Money flowing to the financial intermediaries never leaves the CB system.

    Money flowing to the financial intermediaries increases the supply of loan-funds in the long-term market (more so than any attempt by the Fed to peg rates).


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