Government spending is rising day-by-day. The list includes: $787bn spent for the fiscal stimulus, at least $600bn for the TARP funding, unlimited resources for bank takeovers, loans to the financial institutions, and so on. But on the wake of declining tax revenues, how are those programs being financed? And more importantly, who is paying for it?
Indeed, its common sense among many politicians that during difficult times, economies need to be boosted either by fiscal or by monetary policy. For instance, the US government is using fiscal stimulus to revive consumer demand, stimulate investments and stop employment decline. And the Federal Reserve is lowering interest rates, purchasing treasuries and mortgage-backed securities to ensure credit availability.
The problem is that in many cases countries don’t have enough resources to provide fiscal stimulus. So many of them use so called debt monetarization.
In fact, one of the best ways to finance spending is to issue bonds and sell them to investors. However, treasuries may go back to country balance sheet as the Fed prints extra money and buys bonds back in the open market operations. Yet, the increase in money supply typically leads to higher inflation because there is more money available in the system for the same quantity of goods. And with rising consumer prices, everyone loses purchasing power because our savings are worth less as we need to pay more for the same products. To make things even worse, the next step in this vicious-circle is generally higher interest rates as lenders demand an higher compensation for the lost value of their money.
In sum, conducting fiscal and monetary stimulus has short-term benefits but also long-term costs because the credit availability boosted by open market operations is likely to end at the same level where the operation was initiated. So, after an initial boost where investors become more confident, living conditions get suddenly worse. Consumers spend less, production is further cut and unemployment rates start rising even further.
Disclosure: No positions