The states and municipalities happily joined the orgy of spending and
most of them are now deeply in debt. With the easy money the economy
kept expanding. It created extra demand for labor which resulted in
inflow of illegal and legal foreign workers. With the decline in real
estate and stock values, massive destruction of household wealth
occurred and the credit stopped flowing. It caused sharp decline in
consumer spending. Economy slowed down and unemployment grew. It also
became apparent that the financial debt was fraudulently loaned and
financed making repayment a sheer impossibility. The debt which cannot
be repaid doesn't remain constant -- it inflates with time. It
paralyzed the banking system, and without a renewed lending and
borrowing cycle the economy cannot function. But even today the
federal, state and local governments continue with budget profiles that
are out of control. It leads to further sharp increases in the deficits
and deepens the economic crisis. Can fiscal policy help us to avoid the
catastrophe?
The Obama administration continues with fiscal policies of his
predecessor. The debate concentrates around the issue of how large the
government fiscal intervention should be and Congress came up with $789
billion stimulus package and the Treasury wants another $2.5 trillion.
There is little debate as to whether such spending is desirable. In
2008 stimulus didn't work and the economy is in deeper recession with
additional $177 billion in debt. The problem is that government sector
is much smaller than the private sector. The leading economists now say
that it is entirely possible that surge in government spending may fail
regardless of the size of the intervention. President Roosevelt's
programs in the '30s kept the unemployment rate in double digits and
the economy declined some 50 percent. The massive spending during the
war seemed to validate the Keynesian theory of deficit spending. But
later experience made it clear that the Keynesian model cannot help the
government to tune the economy. The policy therefore shifted to
monetary policy. Recently, however, it became clear that monetary
policy based on Friedman's strategy to expand the money supply may not
work in a period of extreme indebtedness. If these theories don't work
the government may not prevent the economic downfall while increasing
the existing foundation for vicious economic collapse. The GDP can
decline at a very rapid rate. During the Great Depression the GDP
contracted about 50 percent. There is a growing suspicion that in our
situation fiscal and monetary policies are useless. So why are
Washington and governments around the world coming up with massive
fiscal spending programs?
It is hard for economists to accept the fact that they are of little
help. During 1970 recession a poll showed top economists on a par with
astrologers. It made Allan Greenspan wonder what astrologers had done
wrong. Ronald Reagan used to tell a story about the May Day parade in
Moscow. A few badly dressed civilians follow battalions of elite troops
and phalanxes of tanks and nuclear missiles. When security men try to
remove these strangers Brezhnev stops them. "They march on my orders.
They are our economists. No one can cause bigger devastation than
them."
Everybody agrees, however, that only the consumer could do the heavy
lifting. The consumer can help, over an extensive period of time,
recapitalize the banks, repay the growing national debt, repay a record
budget deficit, and finance steeply growing entitlement obligations.
But the consumer is deeply in debt and unemployment is on the raise.
Obama's stimulus clearly aims at job creation. There is a downside
risk, however. A government can maintain artificially the level of
employment, as the Soviet experience showed, but economic activities
run by the government produce unsustainable cost hikes, and thus have
significant detrimental effects on the economy. It can even produce
total monetary collapse and the adoption of inefficient barter economy.
This happened in Russia, after the fall of the Soviet Union. Thus,
President Obama spoke about financing private infrastructure projects
with the stimulus money. It can make a significant difference.
Hopefully fiscal policy experiment will work. If it doesn't work the
program can shift from increased spending to a substantial reduction in
personal and corporate taxes.
Jarosinski lives in Waitsfield.
