The wild fluctuations of the stock market last week seem to be a reaction to the national deficit and the downgrading of American bonds. But, as financial analyst Liaquat Ahamed, points out, investors were dumping stocks and investing in government bonds, despite the downgrade and despite record low interest rates.
So, if financial markets aren’t worried about the full faith and credit of the United States, why is the stock market falling? An alternative view, most prominently expressed by New York Times columnist Paul Krugman, is that the markets have concluded, given the struggling economy, that budget cuts are precisely the wrong medicine for what ails us. The Obama administration was backed into a corner by the S&P downgrade and must now focus on cutting the budget deficit to the exclusion of all other policy objectives. Such austerity — whether achieved through spending cuts or tax increases — at this moment in the business cycle would only exacerbate a slowdown. In this reading, the stock market is preparing itself for the coming double-dip.
If this is the market’s message, what should we do? Instead of instituting deeper budget cuts and other austerity measures, the government should pursue the opposite: It should take advantage of the fact that it can essentially borrow for free to finance badly needed infrastructure investments. After all, our airports, roads and bridges are in need of urgent repair, and the extra investment would provide job opportunities and inject money into the economy.
Expect that to be the Democrats’ position, that we should stop worrying about the deficit and spend even more money to create jobs and get the economy going. Mr. Ahamed says, however, that this isn’t politically possible. Mainly because ordinary Americans saw the government bailing out big banks and corporations, but doing nothing to bail them out. He proposes a different kind of government activism aimed specifically at consumers and homeowners, which, I suspect, may also become Democratic proposals:
A large-scale government program to restructure residential mortgages and help households refinance underwater mortgages would reduce the debt overhang and support consumer demand. Most important, by channeling public money to help individual families, rather than Wall Street, this initiative could alter the political dynamics that currently doom any government efforts to jump-start the economy.
Can you answer this take on the economic problems and what government might do about them?