Economic Slide Makes Spending Respectable

U.S. economic policymakers have failed for almost a year to respond adequately to the looming global recession.

The calamitous events of Sept. 11 certainly strengthen the recessionary forces. But they have also made the solution to the recession--large-scale injections of government spending, even if the federal surplus evaporates--both obvious and politically irresistible.

Federal Reserve Chairman Alan Greenspan has cut short-term interest rates eight times this year, bringing rates down from 6.5% to an eight-year low of 3%. But unemployment jumped from 4.4% to 4.9% in August, consumer confidence was at an eight-year low, and the stock market had been falling broadly for nearly two years. Conditions in Japan, Europe and most developing economies were at least as bad.

Greenspan’s interest rate cut last week sought to encourage the stock market once it reopened after the terrorist attacks. But the Dow Jones index still fell by 7% Monday, and the other indexes experienced similarly sharp declines. The market kept tumbling all week, suffering its largest one-week drop since the Depression.

The rampaging stock market had been the economy’s primary growth engine for most of the 1990s. But this pattern was unsustainable because it encouraged both businesses and households to borrow heavily to finance investment and consumption spending.

Private-sector debt burdens thus became severe when the market bubble burst 18 months ago. This has weakened any positive impact of Greenspan’s interest rate cuts.

The $300 rebate checks households are receiving barely register against such destabilizing financial forces.

Still, before Sept. 11, the largest obstacle to countering the recession was the completely unfounded belief that the federal government’s surplus was the bedrock of prosperity that had to be guarded, even in a recession. When the government runs a surplus, this means it is collecting more in tax dollars than it is injecting into the economy as spending. But increased government spending--to hire workers and buy products already sitting on businesses’ shelves--is precisely what is needed to fight a recession as private-sector spending slumps.

The Sept. 11 calamity has finally made increased government spending politically respectable, even if it means moving the non-Social Security federal budget into a deficit.

On Sept. 14, Congress committed $40 billion for disaster relief, reconstruction, increased transportation security and countering terrorism. Senate Majority Leader Tom Daschle (D-S.D.) said this amount was just a “minimal down payment” to what will be required.

Even if we were to rapidly inject $200 billion--combining a wider range of government spending and immediate cuts in payroll deductions--it would directly increase national spending by only about 2%. But such an injection would also bring positive ripple effects: benefiting the airlines and other severely damaged industries, encouraging firms to avoid layoffs and counteracting the declines in households’ incomes. Equally important benefits will flow to other countries that depend heavily on selling their exports in the U.S. market.

By contrast, the Republican proposal to cut capital gains taxes provides no such benefits. This simply increases the after-tax reward for selling stocks and bonds at a profit, which is more likely to encourage a new round of stock market speculation than increase new private sector investments in capital equipment. Just as with this year’s initial Bush tax cut, it will also reduce the revenues available to the government to pursue an effective post-Sept. 11 spending program while redistributing income to the wealthy.

Of course, the controversy over increased government spending concerns whether the funds will be used effectively. One standard appropriate to the recent attacks would seem clear: to use government funds to protect innocent people everywhere from further terrorist attacks as well as self-defeating cycles of violent reprisals.

Increasing government spending is no magic bullet. But it will be a force for good by reducing the spread of unemployment, poverty and social despair that would accompany a severe global recession.