Politics stymies US recovery

Dennis Morrison, Contributor

Last year, the consensus among leading economists, including the chief advisers to the International Monetary Fund (IMF), was that without massive public spending by the United States and other major economies, the world would not have been able to avert a second Great Depression.

The knock-on effects from a collapsing financial system had sent the major Western economies, and the US in particular, sliding as investors panicked, credit dried up, and businesses and consumers drastically cut back spending. In short order, households and businesses lost tens of trillions of dollars of wealth as stock markets careened to record low levels, and the commodity bubble and housing bubble burst.

The word was that even if it meant that governments would have to run up huge fiscal deficits and print money, there was no alternative to increased public spending if demand were not to collapse, and if an economic free-fall were to be avoided. Leaders of the major economies, G20 countries, including new economic giants China, India and Brazil, moved swiftly to implement stimulative policies, through the IMF and other multilateral institutions and within their own countries, in a co-ordinated effort to stabilise the global economy and to promote recovery.

It was not long, however, before conservative politicians in the United States in particular were to take up a hard right ideological stance on the issue of government spending, fiscal deficits, and public debt. First, they poured scorn on the bail-out of financial institutions begun in September 2008, and then as the Obama stimulus package was passed, they denounced it as a massive waste of public funds that would hasten the bankruptcy of the country. Ironically, their attacks became even more ferocious as the US economy stabilised and signs of recovery emerged, in response to the monetary and fiscal stimulative measures.

Cautious optimism

Still, there was, overall, cautious optimism in the US as 2009 ended with the rate of monthly job losses falling, the stock market on the rise, and credit markets thawing. The rhetoric against stimulus spending was, of course, gaining traction because of the mounting level of despair as unemployment continued to rise. Despite action taken to stabilise the housing market, including tax credits and the low mortgage rates, home foreclosures were also climbing, leaving the market in a disastrous state, a powerful force of discontent.

In Europe, the recession had been less severe, but by early 2010, a fresh burst of volatility hit financial markets as fear spread about debt default by the so-called PIGS [Portugal, Ireland, Greece and Spain], which was felt could possibly lead to a second financial crisis. Suddenly, the focus shifted in Europe and America from implementing fiscal stimulus to speed-up recovery, to designing budget deficit cuts thought necessary if financial markets were to be placated.

Opinion among economists, including at the IMF, so strongly in favour of fiscal expansion a year before, turned in favour of fiscal tightening, especially cuts in public spending. This, even though the major developed economies were still in the early phase of recovery, and demand in the US, the main driver of the global economy, remained weak, depressed by the high unemploy-ment rate and poor conditions in the housing market. By mid-year, the austerity psychology had taken hold in Europe, and the sentiment spread to the US where volatility in the stock market increased, consumers braced for tough times, slowing spending, and with it the recovery.

Fear of a relapse

But now that the arguments in favour of austerity have gained credibility, the fear of a relapse in the global economy has re-emerged. Most prominent among the voices cautioning against too hasty action to reduce spending in major economies are those of two of the IMF's most senior economists who are arguing that fiscal austerity should come in later years. According to them, fiscal stimulus programmes should be allowed to run their course so as not to threaten the recovery. They further argue that contrary to the rhetoric of conservative politicians and ideo-logues, it is not the stimulus programmes or the financial bail-outs that have created the debt problems in Europe and America.

It would appear that financial markets have, as well, become more worried about stagflation - high unemployment and weak demand - than about fiscal deficit. Evidence of this is that in recent weeks, interest rates in Europe and in the United States have gone down, rather than going up, as had been predicted by the deficit hawks. Uncertain about the economic recovery and fearing that job losses will continue at high levels, US consumers are pulling back, which will push up the savings rate and keep interest rates low.

This is the paradox of the US economy, that growth within that country's economic structure requires high levels of consumer spending, which means lower levels of savings and greater debt - exactly the causes of the crisis! But unless businesses have confidence that consumer spending is going to pick up, they are going to be reluctant to boost production, and increase hiring, which are what is necessary to reduce unemployment. Thus, consumer spending has to be stimulated by fiscal measures until the recovery has taken root - which is a no-no for right-wing ideologues whose rhetoric now dominates public discourse in America.

The disjuncture between the current American political mood and the policies needed to fix its economy could cause the recovery to stall.

Dennis Morrison is an economist. Feedback may be sent to columns@gleanerjm.com.