By Scott Lanman and Vivien Lou Chen
Federal Reserve officials, after taking the historic step of cutting the benchmark interest rate to as low as zero, are calling for greater government spending to help revive the U.S. economy.
San Francisco Fed President Janet Yellen said yesterday at an economics conference in San Francisco that “it’s worth pulling out all the stops” with an economic recovery package. Charles Evans, president of the Chicago Fed, told the same gathering he believes a “big stimulus is appropriate.”
The remarks underscore the view of many economists that unprecedented fiscal measures are needed to combat the yearlong recession, and come ahead of meetings this week between President-elect Barack Obama and congressional leaders. They also reflect the failure of Fed efforts so far, including record rate cuts, emergency lending programs and backstops for debt markets, to halt the crisis.
“There seems to be a consensus push to make it larger and larger,” Michael Darda, chief economist at MKM Partners LP in Greenwich, Connecticut, said in an interview with Bloomberg Television, referring to the coming stimulus package. While “it certainly helps” and will “create some jobs,” the economy may not turn around until 2010, he said.
Yellen, Evans and other officials at the conference didn’t specify their recommendations for the size of the stimulus. Obama is asking that tax cuts make up 40 percent of a package that may be worth as much as $775 billion, a Democratic aide said yesterday. Yellen said she favors a “diversified package of policies” that includes government spending.
$500 Billion Question
“Fiscal stimulus has got to be an important part of the package” implemented by the federal government, Frederic Mishkin, a former Fed governor, said yesterday at the conference in San Francisco. The "$500 billion-plus question” is, “can they get it right?” he said.
The “financial shock” that caused the current crisis is “worse than the one that happened during the Great Depression,” he said. Mishkin left the central bank in August and returned to his post as a professor of economics at Columbia University.
The stimulus that emerges from talks between Obama’s aides and Congress will be much larger than the $150 billion proposal from lawmakers in October, when Chairman Ben S. Bernanke endorsed the concept of such a program. He noted then that the impact of the $168 billion stimulus a year ago had waned.
Tax Cuts, Spending
Obama, who has picked New York Fed President Timothy Geithner as his Treasury secretary, is honing a combination of tax cuts and spending on roads, bridges and other infrastructure to create or save 3 million jobs. Economists and a group of Democratic governors led by New Jersey’s Jon Corzine have called for a $1 trillion program. Obama takes office Jan. 20.
Bernanke, who took office in February 2006, shunned recommendations on specific tax and spending policies during his first two years as chairman, telling congressional members it was up to them to decide on fiscal matters. As the economic and financial turmoil worsened last year, the former Princeton University economist and Great Depression scholar advocated an increasing role for fiscal policy.
“The current downturn is likely to be far longer and deeper than the ‘garden-variety’ recession,” Yellen, who became chief of the San Francisco Fed in 2004, said in a speech. “If ever, in my professional career, there was a time for active, discretionary fiscal stimulus, it is now.”
Clinton’s Adviser
Yellen was an adviser to the last Democratic president, Bill Clinton, serving as chairman of his Council of Economic Advisers from 1997 to 1999 after a stint as a Fed governor in Washington.
Last month, Fed policy makers reduced their target for the federal funds rate, or the rate banks charge one another for overnight loans, to as low as zero for the first time in an attempt to end the longest economic slump in a quarter-century.
The central bank is also shifting its focus to the amount and type of debt it buys, with announcements of new lending programs or asset purchases serving as the principal signals of policy.
Economic data released last week show U.S. consumer confidence sinking to the lowest level in at least 41 years and home prices in 20 major cities declining at the fastest rate on record. Another report showed that the decline in U.S. manufacturing deepened in December.
“The current downturn is likely to last much longer than previous ones,” said Harvard University economics professor Martin Feldstein, former president of the National Bureau of Economic Research. “So, fiscal policy is likely to be useful.”
Budget Burden
Still, such stimulus would increase the long-term burden on taxpayers, Evans said in his Jan. 3 speech.
“Federal debt held by the public is 38 percent of GDP, states have large unfunded liabilities and growing numbers of retiring baby-boomers will further pressure the unfunded liabilities for Social Security and Medicare,” Evans said.
University of Chicago professor Raghuram Rajan, former chief economist at the International Monetary Fund, said in an interview at the conference that he’s “in the crowd that is a little more skeptical” about a federal effort to rejuvenate the economy, especially a proposal to provide federal funds to states.
“The U.S. is of course central to the world economy, and so getting the U.S. back on track I think is very important,” Rajan said. “The real issue is cleaning up the financial sector,” he said, adding he wants to see from the Obama administration a “clear plan” of how to handle “weak” companies.
Auto Industry
The outgoing Bush administration has thrown a lifeline to the troubled automobile industry, granting loans worth $13.4 billion to keep General Motors Corp. and Chrysler LLC from bankruptcy for now. The U.S. Treasury also threw the door open to taxpayer financing for a widening array of companies and industries last week, drafting broad guidelines on aid to the auto industry.
Treasury guidelines would let officials provide funds to any company they deem important to making or financing cars. That left room for the government to provide money from the $700 billion Troubled Asset Relief Program beyond loans already committed to GM, Chrysler and GMAC LLC.
Mishkin said working as a Fed policy maker during the credit crisis is similar to serving in a wartime Pentagon.
The central bank is “fighting a war,” he said. Instead of deploying “tanks and guns,” it’s “monetary policy, credit policy and liquidity policy.”
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