The US has managed to get itself in a no-win situation on many fronts. Try the usual trick of fiscal stimulus to combat a downturn, and our friendly foreign funding sources are likely to take a dimmer view of Treasuries. Higher interest rates (in a worst case scenario, a dollar crisis) could easily counter any boost provided by injecting more money into the economy.
Now we have written before that we think that the costs of preventing recessions are underestimated, but we may find ourselves in a considerably-worse-than-garden-variety recession, so Extreme Measures may be taken, like it or not. And if things deteriorate considerably, they could even turn out to be the least bad option.
Thus, if one is going to consider borrowing, investing in productive assets and projects not only provides income that will hopefully cover the cost of funds, but can also produce intangible benefits. For instance, it would behoove the US to take the lead in clean energy, not only because it is a growing market, but it would provide positive externalities (a better environment) and would help the US maintain its image as a technologically advanced, innovation-oriented economy.
Felix Rohatyn and Everett Ehrlich in today’s Financial Times suggest a program of fiscal remedies focused on what they consider to be the America’s big needs, with infrastructure front and center. It is more a discussion of priorities and a list of ideas that they consider promising than a definitive proposal. Consider it version 2.0 of the “rescue the economy” program.
From the Financial Times.
Ben Bernanke, Federal Reserve chairman, this week alluded to an economy facing “numerous difficulties”. In fact there are only two, but each alone is cause for genuine concern over the US economy’s prospects: first, an implosion of the financial system triggered by the teetering housing market; and, second, record prices for oil and other commodities that are largely driven by events abroad.
Policymaking in the past year has shuttled ineffectively between these two fronts. One day all eyes are focused on the prospective collapse of Fannie Mae and Freddie Mac and the next day we are pre occupied with the prospect of $200, or $500, oil. It is time to devise a programme to promote overall economic recovery by fighting for the economy’s future on both fronts simultaneously.
Six months or so ago, the Bush ad ministration and Congress approved a plan to provide about $200bn (€126bn, £100bn) of temporary economic stimulus aimed at the consumer. But this seems likely to fall short of bringing about a turnround. House Democrats are said to be weighing a package of tax rebates, spending and revenue-sharing along the lines suggested below. Well, they should – we must consider a broader government-financed programme with a greater focus on long-term investment.
If the government is going to stimulate the economy, it should start by expanding investment. Senators Christopher Dodd and Chuck Hagel have submitted a bill providing for the creation of a national infrastructure bank, which would provide assistance to state and local governments to inc rease investment in infrastructure. With an initial capital base of $60bn and the ability to insure the bonds of state and local governments, provide targeted and precise subsidies and issue its own 30-50-year bonds, the bank could easily provide $250bn of new capital to invest in local infrastructure over five years, which would also create several million new jobs, just as the domestic recession threatens to gain momentum.
At the same time, the federal government could initiate a revenue-sharing programme of as much as an additional $250bn to state and local governments to maintain service levels. Assistance to local schools should be a priority. Alternatively, some of this amount could be used to fund a partial Social Security tax holiday for employers, in order to maintain job creation.
On the financial front, the Treasury’s proposal to salvage Fannie Mae and Freddie Mac is a good start and may solve the problem. But we must be prepared to take further steps if needed. One option would be to design terms on which the Treasury would create “certificates” that would be swapped for conforming mortgage assets up to a predetermined percentage of banks’ capitalisation, together with a schedule for swapping these certificates back to the Treasury over the next three to five years. This would give banks breathing space to meet capital standards while the housing market stabilised. The prospect for government participation in any upside could parallel the Chrysler bailout that worked quite successfully almost 30 years ago.
A pervasive lack of confidence in our economy and our government is as serious a threat as a deterioration of the balance sheets of our financial sector. More over, a stable financial system is as important to renewed economic growth as is any fiscal stimulus, much as confidence in sustained aggregate demand is as important as balance sheet integrity to the financial system. But we should learn from our mistakes and act pragmatically to regulate markets as they exist in fact, not theory. The repeal of the Glass-Steagall Act, coupled with cheap money and tolerance for ever greater risk, led to this situation. Unbridled use of short-selling can be destructive of value and contrary to growth and investment. Speculation may play a role in the rise in commodities prices and, if so, risks more pain if the commodities bubble bursts.
A presidential election should not keep us from dealing with these problems. A powerful bipartisan programme of fiscal stimulus, financial restoration and regulatory vigilance should be considered. Such a programme could help us to avoid the worst recession in almost 30 years.