Resident Fellow Desmond Lachman

The key macro-economic policy question right now would seem to be not so much whether an US$800 billion fiscal stimulus package is sufficient to jump start a faltering US economy. Rather it is whether the fiscal stimulus package is (a) sufficiently front-loaded and (b) sufficiently well-designed to provide the immediate support so desperately needed by a US economy caught in the grips of a downward spiral. Sadly, the stimulus package presently wending its way through Congress appears to be sorely wanting on both counts, which makes it very difficult to be optimistic about its prospects for eventual success.

The all too apparent deterioration in the US economy over the past few months, as evidenced for example by employment now declining by more than 500,000 jobs a month, would suggest the need for powerful and immediate policy support. Yet the Congressional Budget Office estimates that at best only around US$170 billion of the US$800 billion fiscal stimulus package would find its way into the economy before September 30, 2009. Worse still, almost 40 percent of the package takes the form of tax cuts, many of which are all too similar to those that proved to be rather ineffective in 2008, while too much of the spending package is on infrastructural spending that by its very nature is very slow acting.

With the prospect for only limited fiscal policy support in 2009, there would seem to be increased urgency for the Federal Reserve to be more aggressive in the implementation of its recently announced zero-interest-rate-policy. This would seem to be especially the case at a time when the economy is confronted by the all too real threat of deflation. Beyond purchasing mortgage-backed securities, the obvious place for the Federal Reserve to start would be to buy long-dated government securities, whose yields have backed up by around a full percentage point over the past few weeks. The Federal Reserve might also consider buying government inflation linked bonds (TIPS) as a means of clearly signaling its determination to avoid deflation from taking hold.

More important than monetary policy is the need for bold measures that would mend the country's broken financial system. Here too the indications from the new Administration are not very encouraging. For rather than considering radical policy action like that successfully pursued by Sweden in resolving its banking crisis in the early 1990s, the new Administration seems to be going down the Japanese route of keeping alive Zombie institutions through a combination of liquidity support, bank guarantees, and capital infusions.

Desmond Lachman is a resident fellow at AEI.