Where is Obama's global response?

Posted By Philip Zelikow Friday, January 9, 2009 - 7:51 PM

By Philip Zelikow

I'm uneasy about the way President-elect Obama is framing his case on the stimulus. Instead of a rhetoric of hope, it is a rhetoric of desperate trouble and borrowing our way out of it. This is not very FDR. President-elect Obama's speech yesterday said nothing --nothing! -- about how U.S. efforts would or should relate to what other countries should do. There was no discussion of the global economy or global coordination at all.

I get the domestic politics. And, true, a big move is important just to get a psychological turnaround. Still, rather than promising gigantic borrowing to solve all our problems, it might be more heartening to Americans -- and certainly more heartening to the international audience -- if the United States would arrange a collective effort or statement along with the European Union, China, Japan, and a leading oil exporter (and surplus country) like Saudi Arabia that would describe a global agenda. That agenda should include fiscal stimulus, but with the U.S. role clearly proportionate and sustainable. That might seem more promising, and durable. The agenda would lead with joint efforts to complete the restoration of confidence in the banking system.

The IMF has argued that effective fiscal action should be collective and coordinated, with some allocation of responsibilities that takes different capacities and impacts into account. That kind of spirit is not yet evident in the president-elect's words or deeds.

Starting with the president-elect, prospective officials of the incoming administration always contrast themselves with the outgoing Bush administration by stressing their commitment to diplomacy, to the hard work of acting -- whenever possible -- with others. OK, well a crucial test is at hand. This is an issue of prime importance, especially for billions of the world's poorest, most vulnerable people.

This is not just altruism. Sure, there are the dangers of rising political instability and despair that globalization can ever become inclusive. For the United States, aggravating the global imbalances too sharply may not be a durable way out of the crisis, as we take too much capital from places and opportunities where it could do more good in lifting all boats, including ours.

It helps to remember where the U.S. government got the money for the classic (though disputed) story of fiscal stimulus success: mobilization for World War II ending the Great Depression. It borrowed the money from American firms and the American people. That was what all those war bonds drives were about, reinforced by the constrained choices for consumption and investment in light of wartime controls.

In the current stimulus plans, the United States would borrow at least an extra trillion dollars from the world, as well as U.S. investors. Right now this looks highly doable, without jacking up interest rates, since there is a huge appetite for the safety of U.S. treasuries. But, as the IMF warned last week, the current low rates should offer "limited comfort, as markets often react late and abruptly" to changing perceptions about fiscal sustainability and alternative investments. This would especially be true as investors roll over short-term Treasury paper and contemplate buying longer-term T-bills.

It is worth examining the global consequences of U.S. success. If U.S. securities can soak up nearly a trillion more dollars of the world's investment capital in 2009 and 2010, is this a good thing for the United States and world economy? The U.S. government might well prevail in a global competition for capital. But then, would there be losers? Would they be European and Asian economies? Emerging markets with more vulnerable people and large opportunities for growth? The equity market?

If the underlying financial crisis is effectively addressed and banks feel they can now exploit the encouraging monetary environment to offer credit, and some significant recovery begins in 2009-10, this opening could come at the time the United States would be making maximal claims for capital. From a global perspective, would U.S. government fiscal stimulus then be the most productive use of the marginally available extra capital to fuel an incipient recovery?

A "yes" argument could be that U.S. government spending might have a better multiplier effect on demand than would spending in many other advanced or emerging economies. The "yes" argument could then say that U.S. demand is still the best, the indispensable, way to lift all boats.

But a "no" argument might emphasize the greater fiscal space for government investment elsewhere and the superior multiplier effects of private investment over public spending. The United States should play some role in stimulating recovery, but if it plays a dominant role, the country might inadvertently inflict severe damage on others as it helps itself. This would be a new version of the 1933-1934 "beggar-thy-neighbor" problem. And, arguably, overreliance on U.S. demand was a root cause of the global imbalance that helped produce this crisis.

I'm not arguing for a fiscal austerity program. But we do have to recognize that our domestic choices and actions have huge international ramifications -- ones that will definitely affect in one way or another.

COMMENTS (0)

EXPLORE:ECONOMICS, ECONOMICS

The Obama administration's fiscal acrobatics

Posted By Philip Zelikow Friday, January 9, 2009 - 5:11 PM

By Philip Zelikow

As a preface, calculators should note that the stimulus package is not the only major fiscal policy measure the Obama administration will propose. For example, the new administration will likely give a high priority to a comprehensive national health care plan as well. I have no opinion on the merits of this policy, but -- if enacted -- such a program does seem likely to require some large federal outlays as it is phased in, probably building at least another $100 billion into annual outlays for the foreseeable future.

The sensible economists in the Obama administration team get all this. They know very well that all the best economists stress that the big fiscal injection must be temporary -- and, perhaps even more important, be seen as temporary. Thus they will argue hard to improve "fiscal governance" to reassure everyone that this will be so. Otherwise the results might be very bad indeed. So these good economic advisers are probably envisioning a policy design choreography that would unfold something like this:

Step One: Massive increase in federal spending and tax cuts for stimulus/investment/heath care, etc. during 2009-2010 (yielding political benefits for them in the 2010 midterm election).

Step Two: Automatic or semi-automatic turnoff of the federal stimulus faucet in 2011. The world must see that the faucet was on a timer and will shut off.

Step Three: Allow the Bush tax cuts to expire in 2010, so that federal taxes will increase as the economy heats up. This shows the world the U.S. program has fiscal sustainability and will have countercyclical cooling.

And then...

Step Four: Reduce risks about U.S. solvency by developing medium-term and long-term fiscal plans and reforms to show that the U.S. is acting to avert entitlement bankruptcy.

Hmmm. If it works, the U.S. government will pull a lot of Gs in executing those hairpin turns.

So the question is: Do observers assess that the Obama administration and the Congress will probably be able to pull off these fiscal acrobatics? Then, after you have done that political assessment, weigh the balance of risks, remembering that U.S. solvency is the foundation of U.S. and perhaps global security.

Aside from all the usual arguments folks can then have about how the political process might work, I'll add just this one: Remember that it is harder to turn off stimulus spending if the capital investments are to be followed by large, continuing costs to operate the new things one has built. (Or, as the US painfully discovered so often in Iraq, bad things happen when the relevant local authority can't or won't operate what you've built for them.

COMMENTS (0)

EXPLORE:ECONOMICS, ECONOMICS

The dubious impact of the stimulus

Posted By Philip Zelikow Friday, January 9, 2009 - 4:41 PM

By Philip Zelikow

The roots of the financial crisis may have been the fall in aggregate demand, and globally, the fundamentals for a recovery of aggregate demand may already be there, waiting for the credit hydraulics to recover. Still, the United States is not the ideal candidate to lead a global spur in aggregate demand. After all, before the crisis, the United States already had weak savings, large and persistent current account deficits, and a debt to GDP ratio which, though it had not yet reached an alarming level, was too large for comfort.

The impact of massive stimulus is highly uncertain. The debaters are not likely to acknowledge how weak the evidence is on this. In October 2008, the IMF summarized that: "Perhaps surprisingly, the empirical literature on the effects of fiscal policy does not provide a clear answer to the simple question of whether discretionary fiscal policy [as opposed to automatic stabilizers like unemployment benefits] can successfully stimulate the economy during downturns."

If the rise in aggregate demand is diffused globally, the effects will be more diffuse. If the Congress attempts to impose "buy America" restrictions on the money, then another very dangerous set of problems will arises.

Rather than measure impact on aggregate demand, some advocates focus on the use of U.S. government spending to create U.S. jobs. The job creation numbers tend to extrapolate a rule of thumb, that every billion dollars of government spending or investment creates about 10,000 jobs. So to create 3 million extra jobs in 2009 and 2010 quickly -- the goal the Obama team has announced -- this back-of-the-envelope arithmetic yields a goal of about $300 billion extra spending in each of those two years.

I am uneasy about the validity of relying on such gigantic macro-extrapolations. There is, even now, deep and unresolved debate about the effect of fiscal policy on US recovery in the most well-studied, classic case, the U.S. economic revival between 1938 and 1942.

It is important to be fair to the proponents: there is evidence that fiscal stimulus can have positive effects. But the details are important. In a good case, with the right associated conditions, the IMF's review of the data suggests that spending an extra 2 percent of GDP to revive the economy in 2009 and another 2 percent again in 2010 (for a total of $600 billion) might add about 0.2 percent of GDP spur on impact in the first year, rising to a cumulative injection of 2 percent of GDP improvement after 3 years. Thus, in this extrapolation, the U.S. economy might be growing at a rate of about 1.5 percent more than would otherwise be the case by 2012, and 2 percent hotter in 2013. This is potentially positive reinforcement for the administration's case.

But then notice two things:

One, the lag effect in the best case, heating up an economy which may already be in recovery. If there is a lot of pent-up global aggregate demand and since, in the current case, the monetary gas pedal has been floored, we could be setting up another "great inflation" in the medium-term. On this, check out Robert Samuelson's current book, which recounts the important, suggestive story of the 1960s and 1970s.

And two, partly from anticipating just this danger, if the U.S. moves into high debt to GDP ratios, the IMF data suggests the effects of the stimulus probably won't be positive at all. Instead, per the IMF, the effects of the stimulus could become "consistently large and persistently negative," as doubts grow about fiscal sustainability.

COMMENTS (0)

EXPLORE:ECONOMICS, ECONOMICS

The roots of the financial crisis

Posted By Philip Zelikow Friday, January 9, 2009 - 3:51 PM

By Philip Zelikow

Picking up on what I said here about my unease over the stimulus, how then do we diagnose the problem?

The financial crisis was caused by a failure of the global financial system. It was not caused by inadequate aggregate global, or U.S., demand. Even now, the decline in U.S. demand is more of a consequence of the financial crisis, with the popping of asset price bubbles and contraction of credit as banks clean up their balance sheets.

Thus, this crisis is not like the crisis of the 1930s. That crisis certainly included popping bubbles and systemic financial issues, but it was also deeply marked by structural demand problems which many historians lay at the door of the gold standard ("golden fetters") or monetary stringency. These fundamental constraints were compounded by politics-related failures in international coordination, especially within Europe. These aggregate demand problems were then reinforced by the collapse of world trade.

This crisis does not seem as related to inherent strictures in generating aggregate demand. Monetary policy was loose before the crisis. Aggregate demand was strong -- too strong. The Fed was not alarmed, since it measured price stability against indices of consumer prices. And consumer prices remained stable -- at least in part, because the demand was diffused into a vast global supply chain. That supply chain had plenty of room for cheap expansion of capacity. But the huge demand and large global imbalances manifested themselves in another way: the rapid inflation of asset prices.

Asset price inflation was not seen as a threat to "price stability." Yet, to quote from the G-20 Declaration of November 15, 2008, "weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage" were endangering the system. That statement goes on to say that policymakers in the leading countries, including ours, "did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions." This is an unusual spectacle of self-flagellation.

So the first priority is to address the financial crisis, or even the microeconomics of the housing crisis. This is a foreign policy issue: It should include international coordination of intervention policy harmonizing criteria about which institutions or firms to support. It should include international agreement on how best to set new capital requirements. If the underlying crisis goes unresolved while we concentrate on stimulus, the U.S. will be transfusing blood into a patient with blocked arteries. That is why a recent IMF report took care to stress, despite its call for urgent fiscal stimulus, that in past cases of success, "the solution to the financial crisis always precedes the solution to the macroeconomic crisis."

Remember, too, that any major policy initiative has political opportunity costs. To drum up support for a giant stimulus, the President-elect Obama is already putting dire warnings at the top of his communications agenda. Is this message, in essence, one of a desperate need to borrow, really the right message of hope? And, with a huge initial focus on the domestic stimulus/investment package, how vigorously and intensively can the administration simultaneously devote itself to getting global coordination of a common approach to fiscal stimulus, especially from countries with more fiscal space to invest?

Nor is it clear that the stimulus should take precedence over building a predictable global financial framework to rebuild effective operation of the international capital market. And I am also uneasy that the clamor of domestic salvation will drown out attention to protecting the health of the global economy -- including the global trading system -- as it comes under fresh, recessionary pressures.

COMMENTS (0)

EXPLORE:ECONOMICS, ECONOMICS

Shadow Government is a blog about U.S. foreign policy under the Obama administration, written by experienced policy makers from the loyal opposition and curated by Peter D. Feaver and William Inboden.