The odds of a recession in the US must have increased after a very poor employment report, growing evidence of weak holiday spending, further increases in oil prices, more dismal housing data and further writedowns in the financial sector, writes former US treasury secretary Lawrence Summers in a comment article in Monday’s FT.
Summers, who is now Charles W. Eliot university professor at Harvard, notes that his judgement just six weeks ago was that predictions of a US recession seemed “extreme”.
It is now conventional opinion and many fear that there will be a serious recession. Markets now predict the Federal Reserve will provide further stimulus to the economy by cutting rates by an additional 125 basis points on top of the 100 basis points by which they have already been cut so that rates fall to the 3 per cent range. There is now a compelling case for the president and Congress to create a programme of fiscal stimulus to the US economy that could be signed into law in the next several months.
Given the market’s expectation of Fed action, the debate now is not about whether or not to provide macroeconomic stimulus. Instead, the question is whether some of the stimulus should also come from discretionary fiscal policy, says Summers.
A diversified policy approach seems “clearly preferable”, he says, in that a mix of stimulus measures makes the outcome less uncertain. Also fiscal moves will directly help those families bearing the brunt of recession. Fiscal moves should limit interest rate cuts, thereby reducing downward pressure on the dollar, while partial reliance on fiscal policy also mitigates the various risks of bubble creation associated with excessively low interest rates.
That said, fiscal stimulus must be timely, well targeted and it must be temporary - otherwise it risks being counterproductive by raising the spectre of enlarged future deficits, pushing up longer-term interest rates and undermining confidence.
Summers reckons a $50bn-$75bn package implemented over two to three quarters would provide about 1 per cent of GDP in stimulus over the period of its implementation.
This seems large enough to take some burden off monetary policy and yet unlikely, if properly implemented, to risk substantial damage given flexible monetary policy if the economy proves stronger than expected. After many months of behind-the-curve policy, moving to implement such measures seems more prudent than waiting till the necessity of even greater ones has been unambiguously established by further pain.
