Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Sunday, September 11, 2005

Fiscal Inevitability?

I mentioned near the end of an earlier posting today that David Dodge, Governor of the Bank of Canada is concerned about the fact that there is such a huge imbalance between the spending in the US and the saving in the Asian economies. After writing those few lines, I had an opportunity to read the full text of Dodge's prepared remarks [thanks for sending the link, Sean]. Here are some excerpts that do not appear in the MSM [main stream media].

But we should not look to exchange rate movements alone to resolve the existing global imbalances. Within the United States, higher interest rates can be expected to lead to increased savings. Authorities could also encourage greater national savings with a tighter fiscal policy. And they could implement structural reforms to encourage national savings through taxation, social security premiums, and other measures.

But if the United States alone were to act to resolve its imbalance by taking the steps I've just described, it would leave the global economy with much weaker aggregate demand. And so a number of other countries must focus on stimulating domestic demand. This task is made more urgent by the fact that the global economy is currently operating somewhat below capacity. The fact that inflationary pressures are absent globally is evidence of this.

So, how can we stimulate domestic demand outside the United States? Clearly, monetary authorities bear most of the responsibility for stabilizing domestic output in the short run and moving their own economies towards full production capacity. But monetary policy may not be as effective as it could be, if there are problems with an economy's structural or fiscal policies. Thus, the appropriate policy prescription depends on each country's circumstances. Structural reforms to remove market rigidities are important for most of us. Many need to improve or develop their financial system so that savings can be more effectively channeled into investment and households can have improved access to credit. For some, the development of social safety nets would be helpful, so citizens don't feel the need to hold excessive precautionary savings. And for a few, more stimulative fiscal policy would be helpful.

What he said in a nutshell: Eventually the US will have to stop its profligacy, and when they do, the global economy will slow down, perhaps severly. To offset these effects, others will have to stimulate their economies, perhaps via fiscal policy.

If he is correct, then for the sake of long-run efficiency I hope the fiscal policy chosen is tax cuts instead of increased gubmnt spending. But I won't hold my breath.
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