ABELLO: A sorry stimulus



Oscar Abello

Imagine a house fire beginning in the middle of the night. Fire alarms go off, and residents grab some belongings on their hurried way out. Last year a house fire started in the American economy: the sub-prime mortgage crisis. When the fire began, big financial firms started hoarding cash (their most precious belonging) as they “exited.”

Usually, the authorities are quick to respond, and the fire department comes to douse the flames. In this case, it seems as though the authorities – the Federal Reserve – came just a tad too slowly.

The house fire grew too large, lighting fears of recession.

Still, they arrived, and they doused the flames by employing their typical method of lowering the federal funds rate. It may take a while to douse the flames, but it is a sensible method, going straight to the heart of the problem (the fire).

Monetary policy is only one method the government can use to fight against recession, though.

Fiscal policy is the other method. Using fiscal policy is equivalent to building a second house right beside the first house as it burns down. It is expensive, but it does solve the problem of being without a functioning economy.

It also takes longer to construct the new house than to douse the old house fire. Think of this as the gap between whenever the stimulus package passes and when the money will actually have an effect. The checks are scheduled to arrive in May. Afterward, Americans will have to begin using the money, which will have to circulate around the productive economy rather than paying down credit card debt or saving it, if it is to work. That is a lot of cards to hope for in a high-stakes poker game.

Beyond the lag of tax rebates as a stimulus, the Federal Reserve has indeed come to douse the old house fire. America will end up with two houses, where before only one stood.

That would be an additional water bill, heating bill, electricity bill and maybe another cable bill. Life will be more expensive. We call this phenomenon inflation.

In the last U.S. recession, after the dotcom bubble burst and 9/11, the same double-move occurred. President Bush and Congressional Republicans cut taxes and Alan Greenspan’s Federal Reserve cut interest rates. Both contributed to getting out of recession, but afterward the Federal Reserve had to raise interest rates 17 times in a row in order to curb inflation.

This time, as last time, the tax rebates come without accompanying spending cuts. Without balancing rebates with cuts, the U.S. Congress takes a bite out of the national savings, the pool of money available for businesses to use as investment. Decreased business investment may simply cancel out part – if not all – increased consumer spending. America might fall right back where it started: on the verge of recession.

Of course, it is an election year. Politicians would prefer not to seem passive when it comes to recession. Fears of recession grew during the winter recess, so there is little doubt constituents at home raised concerns about the economy. Unfortunately, few politicians have the stomach or the vocabulary to explain that this recession is the Federal Reserve’s job to address, if anyone’s job at all.

It may be the case that this fire just needs to burn, all the way through. The housing bubble, in part caused by the extended period of low interest rates coming out of last recession, has helped build what is simply an unsustainable economy based on borrowing against the value of one’s home to finance consumption.

America simply pinned its hopes and dreams on one type of asset. You might say America deserves a recession.

It is unfortunate that, unlike the dotcom bubble that left in its wake a vastly improved communications network, the housing bubble has not left anything in its wake besides more houses.

America will emerge from the troubles ahead, though perhaps it might do well to pin its hopes and dreams on something, or many things, that will leave the world a better place than before.


Oscar Abello is a senior economics major from Philadelphia, Pa. He can be reached at [email protected]