Given the market’s prediction of Fed policy actions, the debate now is not about whether or not to provide macroeconomic stimulus. That question appears to be settled. The question is whether it is better for all the stimulus to come from discretionary monetary policy or for some of the stimulus to come from discretionary fiscal policy. A diversified policy approach seems clearly preferable in that (i) in a world where judging the impact of policy measures is difficult, the outcome is less uncertain with a diversified mix of stimulus measures; (ii) the proximate impact of fiscal policies is felt by the families bearing the brunt of recession, in contrast to monetary policies whose immediate impact is on financial institutions; (iii) use of fiscal policy reduces the amount by which interest rates have to be reduced, thereby reducing downward pressure on the dollar, which in turn contributes to upward pressure on US inflation and international instability; (iv) partial reliance on fiscal policy mitigates the various risks of bubble creation associated with excessively low interest rates.
Fiscal stimulus is appropriate as insurance because it is the fastest and most reliable way of encouraging short run economic growth at a time when a serious recession downturn would pressure American families, exacerbate financial strains, raise protectionist pressures and hurt the global economy.
Poorly provided fiscal stimulus can have worse side effects than the disease that is to be cured. This suggests close attention to three issues:
First, to be effective, fiscal stimulus must be timely. To be worth undertaking, it must be legislated by the middle of the year and be based on changes in taxes and benefits that can be implemented almost immediately.
Second, fiscal stimulus only works if it is spent so it must be targeted . Targeting should favour those with low incomes and those whose incomes have recently fallen for whom spending is most urgent.
Third, fiscal stimulus, to be maximally effective, must be clearly and credibly temporary – with no significant adverse impact on the deficit for more than a year or so after implementation. Otherwise it risks being counterproductive by raising the spectre of enlarged future deficits pushing up longer-term interest rates and undermining confidence and longer-term growth prospects.
The Democratic candidates agree that the Bush tax cuts needs to be repealed. So, in 2010 we face the largest tax increase in history if that is to be the case. Want to double the dividend and capital gain taxes? Vote for Hillary or Obama. Watch your stocks tank.
They want to "tax the rich" and make more for middle class tax cuts. Sounds nice, but let's look at the facts. The bottom half of taxpayers only pay 3% of the total income taxes collected, which is 1% less than before the Bush tax cuts. 44% of the US population, or 122 million people, pays no income tax at all.
The richest 1% of the country pay 39% of all taxes ($365,000 income and up), which is 3% more than before the Bush tax cuts, under the Clinton tax policy. The top 5% ($145,000) pay 60% of all taxes (up 5% from 1999); and the top 25%, with income over $62,000, pays paid 86% of all taxes. It seems to me that the rich are paying their fair share. Every category is paying more now than under Clinton, except the bottom 75%.
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Ambrose Evans-Pritchard (Telegraph): Bush convenes Plunge Protection Team
“Bears beware. The New Deal of 2008 is in the works. The US Treasury is
about to shower households with rebate cheques to head off a full-blown
slump, and save the Bush presidency. On Friday, Mr Bush convened the
so-called Plunge Protection Team for its first known meeting in the
Oval Office. The black arts unit – officially the President’s Working
Group on Financial Markets – was created after the 1987 crash.
“It appears to have powers to support the markets in a crisis with a host of instruments, mostly by through buying futures contracts on the stock indexes and key credit levers. And it has the means to fry ‘short’ traders in the hottest of oils.
“The team is led by Treasury chief Hank Paulson, ex-Goldman Sachs, a man with a nose for market psychology, and includes Fed chairman Ben Bernanke and the key exchange regulators.
“Judging by a well-briefed report in the Washington Post, a mood of deep alarm has taken hold in the upper echelons of the administration. ‘What everyone’s looking at is what is the fastest way to get money out there,’ said a Bush aide. Emergency measures are now clearly on the agenda, apparently consisting of a mix of tax cuts for businesses and bungs for consumers.
“‘In terms of any stimulus package, we’re considering all options,’ said Mr Bush. This should be interesting to watch. The president is not one for half measures. He has already shown in Iraq and on biofuels that he will pursue policies a l’outrance once he gets the bit between his teeth.”
Source: Ambrose Evans-Pritchard, Telegraph, January 8, 2008.
But some economists fear that lower rates will simply provide a short-lived boost at the expense of the economy’s longer-term health: Cheap money encourages foolish investments, they say, which is precisely how Americans came to experience the evaporation of wealth in the Internet era, followed by housing prices rising beyond any reasonable connection to incomes.
“This appears to be a panic on the part of the Fed,” said Michael T. Darda, chief economist at MKM Partners, a research and trading firm. “The housing bubble was a reaction from the effort to protect us from the collapse of the tech bubble. What’s the next bubble going to be as a consequence of trying to protect us against this?”
Mr. Darda asserts that the economy would be fine if left to its own devices, maintaining that the job market is healthier than most economists think. He contends that the December jobs report is likely to be revised to show that far more jobs were created than the 18,000 reported by the Labor Department.
“That could be important in terms of reversing the direction,” Mr. Darda said. “We need to see evidence that the labor market isn’t falling apart. That’s critical.”
But most economists seem convinced that the economy has slowed significantly, and say it is the severity of a downturn that is in doubt, not the existence of one.
“If we have a recession with a modest consumer retrenchment, and the rest of the world holds up, this could be three quarters of disappointment,” said Robert Barbera, the chief economist of ITG. “The risk is a more dramatic decline for the consumer.”
There is little doubt that the Fed will lower its benchmark rate later this month, making it cheaper for banks to lend money to one another. But there is more doubt whether Washington can quickly agree on fiscal policy moves — that is, raising spending or cutting taxes — in an election year in which the White House and Congress are controlled by different parties.
A recession could pack enormous political consequences. Over the last century, the economy has been in a recession four times in the early part of a presidential election year, according to the National Bureau of Economic Research. In each of those years — 1920, 1932, 1960 and 1980 — the party of the incumbent president lost the election.
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