Now that most economists / analysts and other pundits are rather assured about recession in the US economy, and have started talking about the depth or intensity of it. The blogs are abuzz with the various views on the status of economy. While some predictions are dire, there are others which do not think so. Even though president has referred to a package, there are no specifics detailed. Mr.Larry Summers, former treasury secretary has detailed why the economy needs a fiscal stimulus as well as monetary stimulus.
The fiscal stimulus is of greater importance at this juncture. Firstly, it is an acknowledged fact that any monetary policy stimulus will deliver results with a lag. Considering that monetary policy easing started off approximately 4 months back, the earliest results may be expected in 5 to 6 months. Even this may not happen in considering the argument below.
Monetary policy advocacy postulates that lower interest rates will lead to lower real returns from non-productive hoarding of money by the financial institutions there by encouraging them to lend it to the consumers which in turn will stimulate economic activity. The implicit assumption in this logic is that US economy is treated as a unit not related to, nor influenced by the global economy. The quest for indirect stimulation will not produce results if the financial institutes start investing in, lets say, emerging markets like the BRIC economies instead of the US markets.
Given the impact of low interest rates on dollar, which lead to lower consumer purchasing power resulting in lower domestic economy growth leading to a clamor for still lower interest rates, the only reason a monetary policy ease should be considered would be to ensure that the housing crisis does not deepen. A lower interest rate, will make sense only if, it means lower ARM resets for the average mortgage payment.
However, a fiscal stimulus would directly kick off economic activity domestically which is important for overcoming a recession.
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