CEPR - Center for Economic and Policy Research

World Recession Forces Economic Re-thinking

Mark Weisbrot
The Guardian Unlimited, March 4, 2009
Truthout, March 6, 2009
The Panama News, March 8, 2009
Register Citizen (CT), March 16, 2009

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A serious economic crisis can force some rethinking of economic and political dogma. The current crisis is serious for most of the world; the IMF is projecting world economic growth of just one half percent this year – the worst since World War II – and this number could easily be revised downward.

In the United States, one of the first casualties of the current recession was the extreme fiscal conservatism that has plagued the country for decades. It seems like ages since the Clinton administration, facing projected budget surpluses of more than $5 trillion, decided that it needed to pay off the entire national debt before committing to any new social spending. Obama’s proposed budget has a deficit for this year of 12.3 percent of GDP -- twice the size (relative to the economy) of the next largest deficit in the six decades since the second World War. That was Ronald Reagan’s “military Keynesian” budget of 1983. Like his successor George W. Bush, Reagan never admitted that deficit spending was needed to pull the economy out of recession. Instead he pretended that he was just meeting “defense needs” and granting tax cuts where tax cuts were due (mostly to the wealthy).

Today there is a pretty sizeable consensus that deficit spending is very necessary, whatever the Republican leadership may think – if they are thinking at all. This is really just a matter of national income accounting. With consumption and investment falling, that leaves only government purchases and net exports to pull us out of this recession. More on net exports (exports minus imports) in a minute – but for now this part of our economy is not set to grow enough to pull us out of the recession. Hence the need for the government to step in, in a big way.

Of course, this could be just a temporary change in thinking, with desperation focusing the mind. But there are some signs that it may persist. For example, the New York Times reported on Sunday that Obama’s projected budget deficit for 2013 is “3 percent of the overall economy, a level that economists consider sustainable.”

Indeed this is true, and the arithmetic is simple: if the debt grows at the same rate or slower than the Gross Domestic Product (in nominal terms) it will not grow as a percentage of the economy. That is what matters, not the absolute size of the public debt – a big scary number ($10.9 trillion) that is often thrown around by conservatives. As evident as this is, the major media have almost never looked at the problem in this way before.

Another long-held belief that is currently being challenged in practice but needs to be rethought is the extent to which the government can finance a fiscal stimulus through money creation, rather than by traditional borrowing. The conventional wisdom is that this would dangerously increase inflation. But inflation is falling in most of the world, and in the U.S., prices are actually dropping. The U.S. consumer price index fell at an annual rate of 8.4 percent over the last quarter. Even the core index (excluding food and energy) was up by only 0.9 percent over the quarter, and the rate of inflation has been declining.

The U.S. government has already financed at least $1.2 trillion of borrowing during this crisis by creating money, which was added to the Fed’s balance sheet. This technically adds to the national debt, but since the government owes the money to itself, there is no net outflow of interest payments from the government on this debt. This reduces the long-term debt burden of the necessary stimulus. Clearly there are circumstances under which this “monetizing” of some additional borrowing makes sense because the threat of increasing inflation is minimal. The present economic downward free-fall seems to be such a circumstance.

This has international implications as well. The Obama administration has proposed scaling back at least some foreign aid. Of course, much of our foreign aid is military aid that is often destructive. But it would be a shame to cut back on such life-saving aid that goes to fight AIDS, tuberculosis, malaria, and other diseases that plague the poorest counties – when this funding needs more than ever to be greatly expanded.

On a larger scale, since the dollar has a special status as the world’s reserve currency, the United States could conceivably contribute to the world economic recovery by providing dollars to help developing countries through the international credit crunch and world recession. Our government has done a little bit of this: e.g. it created an international currency swap arrangement of $30 billion each for Brazil, Mexico, South Korea, and Singapore, which added to the hard currency reserves that these countries could tap if necessary. But many countries are not adopting the expansionary macroeconomic policies that they – and the world – need, for fear of running short of foreign exchange.

In other words, the United States – because of the special position of the dollar – could to some extent play the role of a world central bank in the present world recession. This would help stimulate our own economic growth as well by increasing demand for U.S. exports. Of course, if the dollar were to lose value internationally in the process (because of the increased supply of dollars worldwide), this would be an added gain for the U.S. economy.

That is because the U.S. dollar is overvalued, and this overvaluation has artificially stimulated our imports and reduced our exports for many years. The idea that the United States needs a “strong dollar” could be the next widely held economic misconception to bend to reality.

Mark Weisbrot is co-director of the Center for Economic and Policy Research, in Washington, D.C. He received his Ph.D. in economics from the University of Michigan. He is co-author, with Dean Baker, of Social Security: The Phony Crisis (University of Chicago Press, 2000), and has written numerous research papers on economic policy. He is also president of Just Foreign Policy.