It's Too Late for Tax Cuts, Now's the Time To Increase Government Spending

Barry Eichengreen says we need to implement aggressive fiscal policy measures, and those measures need to be coordinated across countries:

Time to grasp the fiscal nettle, by Barry Eichengreen, CIF: ...[G]overnments now need to recognise that they have not just a financial crisis but an economic crisis on their hands. We are well past the point where it makes sense to speak of the possibility or even the unavoidability of recession. ...

What is no longer simply a financial crisis cannot be fixed by financial interventions alone. It cannot be fixed by more interest rate cuts... With consumption and investment both collapsing and only extra-terrestrials to sell additional exports to, there is only one element of global demand left. That's government spending. It is time, in other words, to think about aggressively using fiscal policy.

One can imagine the alarm with which this recommendation will be received. The US deficit is already rising steeply... European countries have uncomfortably high debts and the kind of gloomy demographics that make even existing debts painful to service. But these are problems for tomorrow. The imperative for today is to stabilise the economy. And fiscal policy is the only instrument left for doing this.

Fiscal initiatives will have to be large to succeed in stabilising an economy in freefall. In the US' case, we are talking 5% of GDP, or $700bn (there's that number again). This means that the US deficit may be closer to $2tn than $1tn next year. But desperate times require desperate measures.

The problem with using fiscal policy in a financial crisis, as any emerging market official will tell you, is that it may do more to frighten than reassure investors. Worried that the government's big budget deficits will ultimately have to be financed by printing central bank money, investors may flee the country, causing its currency to crash and creating even more serious financial problems.

Of course, if all governments apply fiscal stimulus at the same time, there is then no reason for investors to flee in any particular direction. There is an urgent need, in other words, for coordinated fiscal (and not just monetary) action.

In the US, we need an income tax cut to put money in the pockets of consumers and an investment tax credit to get corporate spending going again. ... Other countries might prefer a different mix of emergency tax cuts. But they need to act together. ...

He says "there is only one element of global demand left. That's government spending." But then he calls for tax cuts (which stimulate consumption and investment - hopefully).

However, to repeat the point one more time, while tax cuts may have the advantage of immediacy - an important consideration now that we've wasted so much time putting a fiscal policy package in place (it didn't have to be that way) - they do not produce as certain an impact on aggregate demand as government spending. In addition, it's harder to target specific areas of national need such as infrastructure, and tax cuts do not provide aid to state and local governments that are being forced to cut back on development projects and other spending as the weakening economy lowers revenues.

[See also: "Lawmakers Weigh Plan for Stimulus." A combination of tax cuts, the extension of unemployment benefits, the expansion of the food stamp program, and aid to states and cities is proposed. Putting a fiscal stimulus package in place as fast as we can is important - down the line somewhere each day of delay could cost people jobs - so let's hope legislators take the bailout of the innocent bystanders who could be hurt by this crisis as seriously and with as much urgency as they did the bailout of Wall Street.]

Comments

[sheople:]

I had a friend who had a child that lite a fire in a wastebasket under the cabinet. The child shut the cabinet door after he saw what he had done. The fire did not go away. Your idea of throwing more liquidity (gasoline) on a fiscal fire will do nothing but perpetuate the incident. To put it another way, the party's over and we now need to pay the band.

2008 Oct 10 07:37 AM

[john s. gordon:]

directed govt spending in the infrastructure sector can begin the job of refurbishing our transportation sector, the deliberate mining of our infrastructure with no repairs other than temporary bandaids began in 1981 with r.reagan. all $ had to be spent on weapons & nothing on repairs/upgrades. the purpose of an infrastructure is to facilitate commerce, you make the investment & then recoup it later in increased efficiency.
> jack

2008 Oct 10 08:02 AM

[HenryD:]

I agree with sheople, but I think we need to guarantee all bank deposits and loans. Forget the extra spending, we are already in a deep hole & need to take our medicine. A degree of protectionism may also be required.

2008 Oct 10 08:12 AM

[huangjin:]

Government is the least efficient sector of the economy. The bailout plans are insane because they pour more money into housing and finance, which clearly need to shrink. But at least the corrupt and mismanaged are going out of business. Government corruption and mismanagement is still going strong.

A good idea right now would be to abolish several departments, such as Education, Health & Human Services, Commerce, Energy. Suspend most regulations that slow the construction of infrastructure and plant & equipment, such as environmental, prevailing wage, etc. Immediately cut all federal & state & local budgets by 10% and layoff 10% of the government workforce. Start moving people from unproductive government paper pushing into productive private sector work.

2008 Oct 10 08:20 AM

[ajhough:]

We have gone through a long period of less regulation and more tax cuts and larger debts and now we are faced with the results. Phil Gramaph has had his way along with Wendy and Enron. It is too late to sell and nothing to buy.

2008 Oct 10 08:42 AM

[wally in miami:]

The author is right on. WW II ended the Great Depression as the WPA and other programs were too much fanfare and too little in size to make a difference. Because it was a world conflict, no one currency enjoyed an advantage other than the dollar, which had, of course, the advantage of having other people's property serve as the primary battlefield with our resources of blood and guns. We don't need a war with bullets. We need a war against a crumbling infrastructure. The "conservatives" who want us to pull back and take our medicine would have us spend more on lost productivity and capital than would be invested in desperately needed infrastructure. And, of course, at the end of the day we will have the infrastructure. Lest we not forget, it will be private industry building that infrastructure.

2008 Oct 10 09:04 AM

[huangjin:]

Government spending as a share of the economy was mainly flat for the last 40 years, and regulations have been increased across all sectors of the economy. If regulations were actually cut, and not merely changed, there would be fewer lawyers in America, not more.

2008 Oct 10 09:06 AM

[finmah@yaho...:]

So we go back to WPA projects and pork projects from the great depression - I can't wait 10 years. Did it work - no.We have 7 trillion on the sidelines if the government wants more Big Dig projects at 18 billion in Boston - it was money in the wind. How does that entice private investors to jump in and build bridges with state union crews.

Private money now has no allegience to leftist govern and the 7 trillion will go to government who are brave and independant - most likely Asian and East European countries - we will get a bigger flight of capital and reduced revenues Your proposal is a really a disgrace including the logic - the IMF which we ran in bailing out other govern would tell you to pack your bags. We can't stand our own medicine we told other countries - cut favorite pork projects - reduce govern and reduce taxation. Most countries in time like this unless IMF run have turned to socialism and never recovered. Politicians have no abiltiy to determine our economic well being - that is clearly demonstrated by now. This line of thinking is exactly why everyone is moving to the sidelines - somehow politicians will be able to healthcare, housing and now financial markets - increasing their power and diminishing private individuals.

2008 Oct 10 09:07 AM

[whidbey:]

Federal and state Tax holidays will leave money in consumer pockets instantly. Of course the dollar is gone, but nothing is free.

2008 Oct 10 09:19 AM

[blisterchicken:]

Wow, I can't believe niether the author or any of the respondants discussed the obvious causes of the mess we are in. We have given our money over to an independant corporation. We need to get our money backed by somehting sustainable. Gold, Silver, Platinum, would do our money right!

Essentially our money is backed by our SSN numbers and our ability to create wealth & work. Well, there you go, enact NAFTA & PFTA and watch all our wealth trickle away to other countries.

Ross Perot call that one! And the latest person who saw this sinking ship situation is Ron Paul. He specifically called for backing money with precious metals.

The crisis we are going through now is the result of years of shortsightedness from Wall Street. Now we are paying for the short view they took on profit by looking at how much their "year" would improve by all that outsourcing.

Sure stocks went wild in the 90s and it was said to be a great time. But I personally know of 4 people who lost good blue collar jobs. We were soldd the idea and we all bought it.

Basically I've learned that whatever the talking heads are pushing and making excuses for is something the silent majority should stand up and demand does NOT happen. So here we are now, just got sold the 700 Billion Bailout package, and like someone above said, it's like trying to put out a fire with gasoline!

How about an Emergency Tax exemption for everyone! And a 700 million bailout for all the poor souls who have lost their homes, help our cities, and wow, subsidizing a nationwide highspeed mag-lev rail. That at least would create a ton of REAL jobs.

And hell, lets take some of the $700 Billion and build a nice memorial to Smedley Butler. He's the USMC general who won the Metal of Honor twice. HE also gave the speech, War is a Racket. He identified the greed and depravity of the same ilk that has caused this travesty back before WW2.

Now with that said, I still believe in Capitalism, and I still think we will see a grand time ahead. However, I strongly feel we are going to need something close to a massive upheaval of our current money policy, trade policy, and god help us all, our energy policy.

Bernake is commanding a sinking ship, and you can't buy a $700 billion dollar make over for a pig either!

So to fix this we would need to recall all those outsourced jobs! And we all know thats not going to happen. So what then?

Use the governemnts money and power to create situations for people to prosper in, IE - Mag-Lev, wind farms, & solar-construction. Don't use our tax money to fix a system that is flawed, or at least was wrecked by NAFTA & PFTA.

Essentially we need the Taxpayers to retake our country! Right now our policies are too infested with the greed of individuals with limited forsight. We need peopel in power, (CEO's included!) who have a vision for the next 50 years. Then we need to do everything we can to get there.

These short term gain & fixes are destroying the USA.

2008 Oct 10 10:05 AM

[Smarty_Pants:]

Consumer spending used to be over 90% of all spending, now it's only 70% because the government took that extra 20% from the consumer to fritter away on pork and perks for themselves.

If government spending is going to solve all our problems, why not just give ALL our money to the government and let them spend it to take care of us?

It worked great in the USSR, right?

2008 Oct 10 12:01 PM

[Jason Rines...:]

The solution is policy making that spurs private investment into high telecommunications/net... energy, roads everything that creates jobs and upward mobility.

We see the problems that quasi public/private enterprises create with Fannie and Freddie. We see government and particularly Pelosi pushing the 'wind' energy plan by T.Boone Picken (which is really a natural gas plan). The problem with direct government involvement is those in power legislate into there own pocketbooks while ignoring other viable solutions.

Private equity (think number was $4 T and not $7 T) has too much risk in certain industrial and infrastructure sectors based on current regulations to just dive in. And when they do, lobbyists create lawsuits that tie up these projects for years. So government policy should be loosened in these areas with laws changed to not facilitate lawsuits. Government could alsoprovide some big funds to responsible regional banks to loan through the SBA and other programs.

A hefty portion of this current rotten crop of politicians Democrats and Republicans must go and that will take time. I do not expect anything meaningful from this Congress that will largely stay in power or a from a McCain or Obama Presidency.

2008 Oct 10 01:15 PM

[blisterchicken:]

Hello IThinkBig,

You said, "A hefty portion of this current rotten crop of politicians Democrats and Republicans must go and that will take time. I do not expect anything meaningful from this Congress that will largely stay in power or a from a McCain or Obama Presidency. "

Yeah no doubt!

2008 Oct 10 02:11 PM

[TinyTim:]

A sticky issue. No doubt a portion of the bailout going to the public would rev up the economy. Unfortunately, the money would go to consumer goods or to service debt. Govt infrastructure spending is about the most inefficient way to piss away money there is, costing way more than it should. Highways and bridges are pretty shortsighted and without much bang for the buck. What's left? My vote would be energy infrastructure.

2008 Oct 10 03:07 PM

[Smarty_Pants:]

Ultimate solution is the complete free market. Dismantle entire government regulatory system and let people with money of their own decide what to invest in/purchase/save for. Market forces will channel savings to most cost effective use of the capital over time.

Plus all those bureaucrats would have to go find REAL jobs and do something useful for a change instead of make our lives miserable through over-regulation and taxation.

Go Ron Paul!!

2008 Oct 10 04:03 PM

[Jason Rines...:]

I am with you Smarty but the final leg and fall of this big socialist experiment which leads to large wars will occur first.

Liberty is first, Equality is second in how the Framer's founded this nation. Equality said all people should own homes. What tripe and created market manipulations. Liberty tells us this failed experiment that is affecting 300 M people will be harshly punished from those in Congress to Wall Street. It will occur it just takes time to regain our senses.

Pain is the catalyst, unfortunately. We'll get back to Liberty as principle number one again, but first enjoy your pain of the Equality experiment. That is why I could never be a Democrat although the concepts of Equality are important, they are just second. Of course, nowadays being Republican is no better. Replikrats, Demopubs. One and the same group all pushed global Equality at any price over Liberty spouting 'how it's all for the good of the people' while raiding the global citizens bank accounts.

2008 Oct 11 09:27 AM