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The great experiment -- financial bailout and economic stimulus

President Obama describes the current crisis as disastrous. The critics strongly disagree and say that Obama's doomsday scenario doesn't add up. Yet, the situation is critical and it deteriorates.
America has been in a severe debt, yet the borrowing continued against inflated home values while the inflated stocks kept the spirit high. The federal government added to the "prosperity" by borrowing for entitlement and other spending programs.

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.

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