Fiscal Stimulus : Part II

With respect to the last post, Sanjay has raised an interesting point on whether consumer confidence can be raised in any other way without infrastructure spending. This post is an attempt to answer that question. Let's step back and go back to the post "Delevering part I". In that post i had given an illustration on the how the liquidity cycle operates. In the current scenario in US we are facing a deadly combination of fall in consumer demand, fall in private investment and liquidity issues. All of this is exacerbated by the fact that the jobs fall is preceeding output fall currently. In the sense companies are quick to cut jobs. All of this is just to get an idea about the current scenario in US.

Coming back to the question of Sanjay, lets us just think what is the primary reason that will make the consumer start spending again. Stable Income and a sense that the prices are not going to keep falling. Please keep in mind that i am stressing on Stable and not on the quantum of income, to indicate that the consumer should be confident of getting a pay cheque at the end of the month. The three important elements i stated in the first paragraph (liquidity, private investment and consumer spending) are interlinked. The cycle is a self feeding mechanism which moves in both directions swiftly. 

The following steps could be a way of reducing the reverse flow of the cycle (other than the "normal" way).

1.  Government makes firing illegal (other than for illegal and harmful activites by employee)for a short duration of time and gives the companies the flexibility to cut salaries (even of unionised employees).

2.  Floor prices to all assets linked to the prices before the bubble period taking into account the due increases due to inflation.

3.  Make it mandatory for banks to lend/keep the liquidity flow.

These are extreme steps and is a gross manipulation of the market. But we need to consider the fact that in the current scenario market is in a distress and needs to be fixed.

Fiscal Stimulus : Does "productive spending" have any role in revival

Most of the fiscal stimulus plans being announced always have a stress on productive spending. Take for example the view of Mr. Obama, on his big infrastructure push to kick start the US economy. Most of the push of the fiscal plan is on building infrastructure in terms of roads, flyovers etc. The role of such infrastructure spending in restarting the economy has still not be confirmed. Many people relate back to the New Deal era which also was a infrastructure development oriented fiscal plan. 

Whether the New Deal revived the US economy is still an unanswered question. The economy recovered during the 1933-1936 period and then again fell during the recession of 1937. The failure of the New Deal to revive the economy is due to the certain policies that worked at cross purposes. The government was increasing its spending and at the same time cutting the incomes in the hands of the employees, and tried to increase food prices with supply curtailment. All of this restricted the consumption and employment of the people. 

Coming back to the point, fiscal stimulus would be useful only if it is able to stimulate public consumption. Increased consumption by the people is the only way to get out of a deflation. Increasing public spending without increasing the confidence of the people to spend would not be of much use. It would only increase the deficits and make it even more difficult to revive the economy. Japan is a case point in this regard.Care always has to be taken in this regard. Demand revival is important than investments. It is important to know that Keynes never stated that the government spending should be productive only that pay people to dig and fill.