Tuesday, December 14, 2010

US monetary, fiscal pumps get going by default

Business Times - 15 Dec 2010

US monetary, fiscal pumps get going by default


REPUBLICAN and conservative critics of the economic policies pursued by the White House (government spending) and the Federal Reserve (printing money) had hoped that the electoral blow suffered by the Democrats in the recent mid-term congressional elections would force President Barack Obama and Fed chairman Ben Bernanke to change course. It is time to put the brakes on spending by the government and on pumping money by the central bank - and to start cutting the deficit, they insisted.

Now instead, Congress is expected to approve in the coming weeks legislation that, among other things, will extend the Bush-era tax cuts, continue to provide unemployment benefits to jobless Americans, enact a payroll tax holiday, and set up a new estate tax rate.

What some angry conservative pundits are describing as the biggest economic stimulus package in American history - certainly more expansive than Mr Obama's much derided US$787 billion stimulus package, also known as the American Recovery and Reinvestment Act of 2009 - will add close to US$900 billion to the budget deficit.

And there was no indication that the Fed was planning to announce a change in its US$600 billion programme of asset purchases, also known as quantitative easing (QE2), at its policymaking this week. If anything, an expansion of the programme was 'certainly possible' depending on the QE2's 'efficacy' and on how the economy and inflation evolve, Mr Bernanke said on 60 Minutes on Nov 30.

But guess what? Much of the attacks on the proposed deal that would create even more federal debt have come from members of the progressive wing of the Democratic Party who are bashing Mr Obama for agreeing to extend tax cuts to wealthy Americans - and not only to those making under US$200,000 a year (as Mr Obama had pledged during the 2008 presidential campaign).

Mr Obama and his Democratic supporters explained that while the administration was still opposed to extending the tax cuts to the rich, he was willing to accept this Republican demand in exchange for Republican support for the rest of the proposed package that also allows for unemployment benefits and extension of the tax cuts to middle-class Americans that would together amount to an additional US$200 billion in fiscal stimulus. That, together with the payroll tax holiday and other tax breaks, could create incentives for companies - in particular, small businesses - to hire more workers. And voila: The American economy grows!

But what happened to the Republican election 'No More Government Spending' battle-cry? Indeed, why have Republican lawmakers subscribed to Mr Obama's Stimulus Bill II? Have they become born-again Keynesians? Probably not.

It's more likely that Republican lawmakers had been watching television images of rioting students and workers in Europe, especially in Britain, where plans for cuts in government spending and economic austerity have ignited public outcry, and that they may have concluded that putting the cart - federal budget cuts - before the horse - economic recovery - was probably not a brilliant political move, and perhaps not even a wise economic plan.

'You can't get the deficit down, get the debt in the right direction, without economic growth, without job creation', was how Republican Representative Paul Ryan from Wisconsin put it in an interview with The Wall Street Journal. Mr Ryan, one of the Republican economic whiz kids and the incoming chairman of the House Budget Committee admitted that, indeed, Congress would have stifled job creation by not passing the proposed White House-Republican package deal. 'We need growth - and then we need spending cuts and spending controls.'

And while Republican lawmakers have tried to pander to the Tea Party crowd by blasting the Fed and its QE2, they are probably recognising that the central bank is not going to change its policies in response to these political attacks - doing that would risk diminishing the Fed's credibility in the eyes of investors.

Moreover, any clear signs that the economy is growing and beginning to inflate will produce a change in the Fed's policy and lead it to gradually terminate its quantitative easing. It is not clear yet whether the recent rise in bond yields - which could have been higher sans the Fed's QE2 - is a reflection of rising expectations in the markets of economic growth. But the worries over a double-dip recession have disappeared in Washington. The combined effect of the proposed fiscal plan and the aggressive monetary approach of the Fed could prove to be exactly what the economy needed at this stage of the recovery.

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