With the election results this past week, comes the likelihood of a political stalemate as Republican gains create mixed control of the political process. It does not however, alter the economic landscape which we now face. Charting a course through the landmines in front of us, given the lack of consensus, will require strong leadership from the administration, as well as leaders of both houses. On top of this challenge, we have the Federal Reserve embarking on a grand experiment with quantitative easing. Whether monetary policy has any ability to affect economic growth is a question mark, but the Fed clearly feels that they need to do something.
The debate amongst economic pundits and policy makers centers on how best to stimulate the economy. This completely misses the point. What America needs is an intervention, not stimulation. Americans have become consumaholics. What is needed here is recognition that we as Americans have a problem, we spend too much and we need to break the habit. What are needed are not fiscal or monetary enablers, but support as we go through the painful process of breaking our addiction and rebuilding our lives.
Interest rates are at historical lows and Mr. Bernanke has promised to keep them there for however long it takes to restore the health in the economy. This however, is precisely the opposite of what needs be done to restore the economy’s balance, and ultimately its health. Extremely low interest rates only encourage misallocation of capital and serve as an incentive to create debt. This policy is at the expense of thrift and savings. The way to solve a crisis of excess leverage is to reduce leverage. Seems pretty simple. In order to encourage a reduction of leverage, interest rates must go up, providing incentive to save.
Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
Hamlet Act 1, scene 3, 75–77
Unemployment remains stubbornly high, at 9.6%. GDP growth appears to be tailing off after the effects of the various fiscal stimulus packages have run their course. Consequently, debate rages amongst policy makers and economists as to what can and/or should be done to help the economy. On one hand, we have the Keynesians led by the administration who suggest that more fiscal spending need be done to stimulate spending and overall economic growth. On the other side, we have the austerity folks, citing Rogoff and Reinhart, who suggest that the amount of debt now on the Federal balance sheet will permanently hamper growth.
The biggest challenges facing the American economy (and the global economy) are unsustainable debt levels and a lack of job creation. These two go hand in hand, as without job creation debt cannot be serviced adequately, and with the burden of excess debt consumers are unable to increase spending. The good news is progress is being made, as consumers are slowly digging their way out of their financial morase. The bad news is the hole is very deep, and it will take a long time to earn and save our way out of the problem. Policy makers are struggling with ways to assist distressed consumers, but their efforts are not without problem both in terms of implementation and the moral implication of continued bailout.