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Fed Conference Focuses on Deficits and Stimulus
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smartrader
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23-Aug-2009 13:28
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By JON HILSENRATHJACKSON HOLE, Wyo. -- Central bankers don't make tax and spending decisions, but fiscal policy was a major focus of this year's Federal Reserve conference here in the Grand Tetons. Three questions drew attention at a Saturday morning sessions: Are deficits a threat to the outlook that needs more attention? How well is the Obama Administration's fiscal stimulus plan working? And is more stimulus warranted? The answers to the questions: Yes. It not clear. And no. Large, long-term deficits could cause "serious economic disruptions," said economist Alan Auerbach of the University of California at Berkeley, who co-authored a paper presented here with William Gale of the Brookings Institution, a Washington think tank largely populated by Democrats. Over the next decade, they estimated, the U.S. budget deficit will add up to $10 trillion, and possibly more. Credit markets, they added, have begun to signal a risk of U.S. government default, something unheard of just a few years ago. In their paper, the authors gave the Obama administration's stimulus plan a mixed report card. While stimulus was needed, they said, it came a little too late and wasn't optimally designed. For instance, some of the administration's spending programs haven't been implemented quickly. Other programs, like the Making Work Pay tax credit for low-income households, weren't originally conceived as stimulus. Moreover, economists are highly uncertain about whether fiscal stimulus gets much bang for the buck. Obama administration economists estimate that a 1% increase in government spending causes a 1.5% increase in broader economic output, but some private economists say that's too big. Messrs. Auerbach and Gale pointed to the bumpy fiscal path the U.S. traveled in the 1930s and Japan traveled in the 1930s. Efforts to stimulate the economy through fiscal policy often fell short, they said, because of unwise worries about deficits. "The remarkable fact is that sustained fiscal policy expansion was not attempted in either episode," the economists wrote, in part because policy makers were focused on balancing budgets even as they tried to pump stimulus into the economy. The U.S. government, for instance, raised taxes in 1932, as did state governments, and a round of fiscal restraint hit in 1936 and 1937. "By the end of the decade, even with output well below potential and the unemployment rate at 17%, the contribution of fiscal policy to aggregate demand in 1939 was 0.6 percentage points larger than in 1929," they note. But today, the two economists said, more stimulus isn't warranted -- in part because the economy shows signs of recovering and in part because of worries about long-term fiscal woes. One worry for central bankers is that large deficits could push up interest rates, working against their ability to stimulate the economy by keeping rates down. "We have huge budget deficits all over the world," Jacob Frenkel, former governor of the Bank of Israel, said. So far, large deficits don't appear to be a problem in the U.S. Yields on 10-year U.S. Treasury notes, at 3.56%, remain low. But the deficit problem has already affected Fed policy: In March, the Fed launched an effort to bring down long-term interest rates by purchasing long-term government bonds. The theory was that buying the bonds would reduce their supply, push up their price and push down their yield. But officials have been reluctant to expand the program because they worry investors would see purchases of government bonds as an attempt to facilitate large deficits, which could be inflationary. "The best thing we could do right now is announce a credible medium-term consolidation plan," said Maya MacGuineas, a deficit hawk with the New America Foundation, a Washington think tank, who participated in the Jackson Hole conference. Christina Romer, who chairs Mr. Obama's Council of Economic Advisers, said reducing the deficit is a priority for the Obama Administration and that health care reform, which could bring down government health care spending in the long-term, is part of the administration's solution to the problem. "Deficits do matter," she said. "No one believes that more than the president." |
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