It’s frustrating to see the enduring power of rigid and self-satisfied ideology in the midst of the current economic crisis, especially in the areas of fiscal stimulus and bank nationalization. In each case, the evidence points to a certain course of action, while the laissez-faire ideologues protest (too much). Rather than being good economic stewards, these people will cling to ideological preconceptions like life vests after a shipwreck. Let me briefly discuss.
First, fiscal stimulus. I’ve talked about this before. We all know that large increases in the deficit do not bode well for debt sustainability in the future, with a possible solvency and currency crisis manifesting through rising interest rates and a falling dollar. But there is little evidence of this right now, and with the world in recession, the US can yet again take advantage of its reserve currency status as demand for risk-free dollar assets remains high, allowing the US to borrow far more at cheaper prices than other countries.
As Martin Wolf points out in the Financial Times, households are suffering greatly from impaired balance sheets right now–assets such as housing stock and retirement accounts are falling while liabilities or debt remains at historical highs. This means that the number one preoccupation of households right now is paying down debts and building savings, not spending money. This is exactly what happened in Japan during the 1990s. In such a situation, there are only a limited number of ways to stave off a “downward spiral of mass bankruptcy”: boost exports or boost government spending. A global recession rules out the former (this is what got Asia out of its mess a decade ago). That leaves the government. And indeed, it was Japan’s fiscal stimulus that kept the economy on life support, with growth only collapsing in 1997 when the government tried to reduce the deficit. Others have made a similar argument about the Great Depression, as Roosevelt’s spending successfully reduced unemployment from 25 percent to 10 percent, only to be stalled in the late 1930s as the fiscal conservatives gained influence. Remember, the situation in the financial sector means that monetary policy has limited effect, and indeed has reached the limit of what it can accomplish. Fiscal policy or bust.
Opponents of the fiscal stimulus also concerned with composition, arguing that somehow tax cuts will do the job while government spending is wasteful. While this Reaganist shibboleth has become almost conventional wisdom in some parts, it is also wrong. All of the evidence suggests that Keynesian multipliers are larger on the spending that on the tax side, for a very simple reason: tax cuts are partly saved and partly spent, while when the government purchases something, it adds directly to GDP. And as we have seen, households are extremely unlikely to spend tax cuts in the current situation of balance sheet deflation.
Second, bank nationalization. A growing number of experts support this option (see here for an example), and yet it is dismissed by the predictable ideologues as “socialism”. At this point, even Alan Greenspan (Ayn Rand’s old disciple) has come around to the view that the most effective and prudent way of removing toxic assets from banks’ balance sheets is through a temporary nationalization. In fact, the only option is some kind of government intervention, and the form becomes important. The worst way to do it is the Paulson strategy: effectively guaranteeing banks’ liabilities and providing capital while imposing no restrictions on management and allowing limited taxpayer upside. When Fannie and Freddie were recapitalized, the top management was removed immediately. And yet there was no talk of removing the failed management of the private banks, who continued to operate as usual, mis-using taxpayer money. Nationalization would allow the government to recapitalize the banks, wipe out shareholders, get rid of management, and let taxpayers profit from any upside. It would also be easier to transfer the toxic assets to a government-run bad bank, an issue that bedevils any private sector plan. Owing largely to the enduring power of the banking lobby, Geithner is not quite there yet. But it cannot be far off. The nationalization would be strictly temporary, and would yield the best solution– but will it pass the ideology sniff test?
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