Barry Eichengreen says we need to implement aggressive fiscal policy measures, and those measures need to be coordinated across countries:
Time to grasp the fiscal nettle, by Barry Eichengreen, CIF: ...[G]overnments now need to recognise that they have not just a financial crisis but an economic crisis on their hands. We are well past the point where it makes sense to speak of the possibility or even the unavoidability of recession. ...
What is no longer simply a financial crisis cannot be fixed by financial interventions alone. It cannot be fixed by more interest rate cuts... With consumption and investment both collapsing and only extra-terrestrials to sell additional exports to, there is only one element of global demand left. That's government spending. It is time, in other words, to think about aggressively using fiscal policy.
One can imagine the alarm with which this recommendation will be received. The US deficit is already rising steeply... European countries have uncomfortably high debts and the kind of gloomy demographics that make even existing debts painful to service. But these are problems for tomorrow. The imperative for today is to stabilise the economy. And fiscal policy is the only instrument left for doing this.
Fiscal initiatives will have to be large to succeed in stabilising an economy in freefall. In the US case, we are talking 5% of GDP, or $700bn (there's that number again). This means that the US deficit may be closer to $2tn than $1tn next year. But desperate times require desperate measures.
The problem with using fiscal policy in a financial crisis, as any emerging market official will tell you, is that it may do more to frighten than reassure investors. Worried that the government's big budget deficits will ultimately have to be financed by printing central bank money, investors may flee the country, causing its currency to crash and creating even more serious financial problems.
Of course, if all governments apply fiscal stimulus at the same time, there is then no reason for investors to flee in any particular direction. There is an urgent need, in other words, for coordinated fiscal (and not just monetary) action.
In the US, we need an income tax cut to put money in the pockets of consumers and an investment tax credit to get corporate spending going again. ... Other countries might prefer a different mix of emergency tax cuts. But they need to act together. ...
He says "there is only one element of global demand left. That's government spending." But then he calls for tax cuts (which stimulate consumption and investment - hopefully). However, to repeat the point one more time, while tax cuts may have the advantage of immediacy - an important consideration now that we've wasted so much time putting a fiscal policy package in place (it didn't have to be that way) - they do not produce as certain an impact on aggregate demand as government spending. In addition, it's harder to target specific areas of national need such as infrastructure, and tax cuts do not provide aid to state and local government who are being forced to cut back on development projects and other spending as the weakening economy lowers revenues. [See also: "Lawmakers Weigh Plan for Stimulus." A combination of tax cuts, the extension of unemployment benefits, the expansion of the food stamp program, and aid to states and citis is proposed. Putting a fiscal stimulus package in place as fast as we can is important - down the line somewhere each day of delay could cost people jobs - so let's hope legislators take the bail out of the innocent bystanders who could be hurt by this crisis as seriously and with as much urgency as they did the bail out of Wall Street.]