Fiscal Stimulus: The Growing Debate About When to End It

There seems to be a growing body of opinion that suggests it’s time to cut back on stimulus and begin repairing government balance sheets. Are we risking a repeat of 1937?

As reported by Reuters, Jean-Claude Trichet, the President of the European Central Bank, said today that governments cannot amass more debt to fight the recession and should not spend more money doing so.

There is no room for governments that have borrowed billions to fight the economic crisis to accumulate more debt, European Central Bank President Jean-Claude Trichet said on Sunday.

“There is a moment where you can’t spend anymore and you can’t accumulate any more debt. I think we are at that moment,” Trichet told Europe 1 radio.

He said the massive injection of funds into the economy through government stimulus packages had been the appropriate response to the economic crisis but he said states would have to bring public finances back under control as soon as possible.

“We are in exceptional circumstances at the moment,” he said, adding that markets and consumers had to be convinced that governments would return to a normal budget situation.

He said there was very wide agreement that the economy would be showing clear signs of recovery by 2010.

Germany’s Angela Merkel has been singing from the same hymnal and this past week the head of Spain’s central bank informed the government that there was no money left for further fiscal stimulus. You could probably add some countries like China and Russia to the brigade calling for Western countries to slow down their pace of borrowing and spending. That has been implicit in their banter about moving their foreign currency reserves out of the dollar.

So is it time to pull back? Remember in 1937 similar concerns led Roosevelt to tighten and increase taxes with disastrous results. The economy which had been growing nicely and bringing down unemployment plunged almost immediately into another severe recession and umemployment soared by an additional 10%.

An article In MarketWatch today suggests that we are not at all out of the woods.

If the U.S. economy does begin to grow again in the second half of the year as many analysts expect, it sure won’t feel like much of a recovery to most people.

The growth – if it comes – won’t be the sustainable kind that leads to more employment, higher incomes and fatter profits, at least at first. Instead, it’ll most likely be the temporary sort of growth based on changes in inventory levels and the massive support of the federal government.

The green shoots in the economy are real, but they are tender seedlings that still need to be in the greenhouse. If the heat of the government’s stimulus efforts is removed too quickly, the shoots are likely to wither long before they bear fruit.

So far, the best news we’ve received is that the economy is collapsing at a slower rate. Fewer people are losing jobs, fewer firms are losing customers, and the three-year slide in the housing market may be bottoming.

Those are encouraging signals, but they are not the same as sustainable growth. The economy is still mired in a recession, which will continue until jobs, income, sales and output begin to rise again. The economy still faces considerable headwinds: the growing wave of foreclosures, the higher cost of gasoline, the precarious fiscal position of many states, and, above all, the pressing need for American families to save more and spend less.

The MarketWatch article points out that the housing market while showing signs of recovery is doing so on the back of massive federal support. It also notes that as a result of the shutdown of GM and Chrysler during their bankruptcies, durable goods orders are likely to have slipped markedly and, of course, auto sales are themselves still highly depressed. Finally, personal income is growing only because of government cost of living increases and the consumer remains in precarious shape and in no apparent mood to spend.

The article actually seems to be asking, “What recovery?” It does not paint a picture of an economy with any sort of sustained growth, instead one that may have stabilised but could collapse government life support were to be withdrawn.

I suspect that this controversy is going to continue to grow. If the recovery continues apace in the U.S. where only a small percentage of the appropriated stimulus money has been spent, the pressure to cut back is going increase. Recent polls indicated public opinion shifting from concern about recovery to concern about the size of deficits.

There are high stakes involved here that are going to test a lot of nerves before this is all over.

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