The biggest debate in financial markets at the moment is over the need for further government stimulus in the global economy, especially in the United States. Here are the major arguments:
- More Government Stimulus: Championing the case for more government spending to stimulate the global economy is Paul Krugman, winner of the 2008 Nobel Prize in Economics. In a recent article titled The Third Depression, Krugman argues that “while long-term fiscal responsibility is important, slashing [government] spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.”
- Less Government Spending: Although not a direct response to Krugman, one of the more interesting arguments that I found against government stimulus was from the editorial team at the Wall Street Journal: “For going on three years, the developed world’s economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn’t turned out that way.”
- The debate: Keynes vs. Alesina. Alesina Who?
- Video (5 mins): Nouriel Roubini debates Nassim Nicholas Taleb on the role of government in an economy
My take: A quick examination of the components of the U.S. economy/GDP:
Personal consumption
- Most important component of U.S. GDP (over 60% of all economic activity)
- High unemployment rate: According to data from the Bureau of Labor Statistics, the average unemployment rate between 1985 and 2005 was 5.7%. Today, it is about 9.5%
- Deleveraging (debt reduction) by U.S. households: Earlier today, the Federal Reserve announced that consumer credit declined by $9.1 billion in May and by $14.1 billion in April. Less borrowing implies weaker consumer spending
- Based on the above, the current status of personal consumption: WEAK
Private investment
- According to the Wall Street Journal, “nonfinancial companies [have] socked away $1.84 trillion in cash and other liquid assets as of the end of March, up 26% from a year earlier and the largest-ever increase in records going back to 1952. Cash made up about 7% of all company assets, including factories and financial investments, the highest level since 1963.”
- In addition to the hoarding of cash by U.S. companies, the current capacity utilization rate remains below 75%. Thus, given that U.S. companies have room to increase production, capital expenditures – a major part of private investments- might remain weak. As a result, companies are more likely to use their cash holdings to engage in financial transactions, such as stock buybacks and strategic acquisitions, rather than on capex
- Greg Mankiw, professor of economics at Harvard, tries to explain why companies might be holding on to so much cash: “[B]usinesses may be reluctant to invest in an economy that they expect to be distorted by historically unprecedented levels of taxation in the future. The more the government borrows, the higher taxes will need to go, the more distorted the future economy will be, and the less attractive is investment today.”
- Based on the above, the current status of private investment: WEAK
Net exports
- Not much is happening here to stimulate the U.S. economy
- U.S. exports declined from $149.8 billion in March to $148.8 billion in April, the most recent period for which data is available
- A recent quote (06/29/2010) from New York University professor Nouriel Roubini: “A double-dip recession looks likely in the euro zone, it looks like Japan right now is falling off the cliff … and now there is evidence of a slowdown in economic growth also in China.” Given that these are major trading partners of the U.S., net exports probably won’t spur growth in the U.S. economy anytime soon
- Based on the above, the current status of net exports: WEAK
Government expenditures
- This is the final component of GDP that the current debate is revolving around because it is one that policy makers can directly influence in the short-term
- Informative PowerPoint on U.S. government expenditures (Short & Long Term Budget Trends)
- In Government to the Economic Rescue, Alan S. Blinder, professor of economics at Princeton, argues that government intervention (TARP, stimulus package, etc) has been good for the economy
- 2009 Stimulus bill ($787 billion): Tax cuts represented one-third of the total package, fiscal relief to state governments and other social benefits also accounted for one-third, and public investment spending, the “centerpiece” of the bill, ended up being only a third of the final package with the actual outflows spread over multiple years. Compared to the U.S.’ annual GDP of $14 trillion or the $50 trillion decline in global financial assets in 2008 alone, it is no surprise that some prominent economists have argued that the stimulus package was too small. That said, it appears the stimulus has been a great success as it has helped to create almost 2.7 million jobs in the U.S.
FINAL WORDS:
- On monetary stimulus: In their 1963 book, “A Monetary History of the United States, 1867-1960,” Nobel Laureate Milton Friedman and Anna Schwartz argue that a contraction in U.S. money supply contributed to the Great Depression. Given that the Federal Reserve acted promptly at the height of the recent financial crisis by embarking on expansionary monetary policies, i.e., slashing of interest rates and opening of the discount window to more financial institutions, government intervention here seems justified. As a matter of fact, the Fed has been transferring record profits to the U.S. Treasury for the benefit of taxpayers. That said, going forward, the Fed’s ability to successfully exit these expansionary policies remains an open question
- On fiscal stimulus: Keynesianism lives on, and the debate continues
Abraham Tiamiyu