The Politics of Trading Recession for Inflation
On virtually everything economic, the Bush administration and much of Congress have become the gang that can’t shoot straight — and their stray bullets could take down a good piece of the nation’s economic prospects. They have directed hundreds of billions of taxpayer dollars to financial institutions (and soon, auto companies), and they’re getting ready to direct several hundred billion more at the overall economy. In all of these instances, a political drive to display the will and capacity for large actions has overwhelmed deliberate thinking about the specific consequences of those actions. The Obama presidency and the country may pay a big price for this scattershot approach.
The latest example of this dangerous development is the ever-expanding size of the long-awaited, next stimulus. We’re in a deep and serious recession; and major stimulus was certainly needed — mainly six months ago, when the Bush administration and Congress provided tax rebates which were largely saved with little stimulative effect. Now we know how bad the downturn is turning out to be, and Congress and the administration-in-waiting are preparing another stimulus of a size commensurate with what’s already unfolding — once again, as if this were six or eight months ago. A stimulus providing another $200 billion to $300 billion in new federal spending makes sense, mainly as insurance for another shock to the economy. But a $500 billion to $750 package like the one now under discussion will miss its target by many months and mainly indicates that the new rule is, anything goes when you win and damn the consequences.
Congress seems intent on responding to this recession as if everything known about how the business cycle works can be ignored, and the consequences could be serious ones. The Obama team is focused on long-term investments in 21st century energy and transportation infrastructure, modernizing health care records, expanding training and education, and extending broadband and IT access for poor children. That’s all good news for the long-term health of the economy and for the incomes of many households. The catch is, long-term investments entail not a one-time boost in spending, but continuing funding. So, when we raise the ante on those investments from $100 billion or so to $300 billion, $400 billion or $500 billion, we’re implicitly choosing either to foreswear any other commitments, such as health care, or to embrace another round of dangerously large, structural deficits.
Since the new politics seems to involve never saying no, the likely result of the current course, on top of the extraordinary infusions of credit by the Federal Reserve, is serious inflation once the downturn begins to resolve itself. This pattern is disturbingly similar to the short-sighted and cavalier approach to long-term risks that got the nation into this mess. And it continues to develop alongside the Treasury and Congress’s continuing inability to address the rising foreclosures still driving the financial crisis and the credit freeze accelerating the downturn. Yet real responses are within reach: Place a moratorium on foreclosures while Fannie Mae and Freddie Mac renegotiate the terms of millions of troubled mortgages; and link financial bailout funds to a commitment to use them to extend credit to businesses. If we do that, the economy won’t need so much fiscal or monetary stimulus.
The current approach presents other serious risks. This pattern of fast-rising spending, on top of the bailouts already done and those to come, as well as more tax cuts, could push the U.S. deficit to levels that even the United States will have trouble financing. The Asian and Middle Eastern governments that provide much of our public financing could stop — either because they’ll see inflation coming, too, or because the global downturn and falling oil prices sharply reduce their savings and thus their ability to lend them to us. The United States Treasury will always find the funds it needs, but it may have to pay a lot more to borrow them, which means higher interest rates. So the current approach risks an interest rate spike on top of everything else, which at best would lead to a substandard recovery. With all of its talent and broad public support, the Obama presidency should be able to do a lot better than that.