Where is the fiscal policy?

Governments can affect the economy in two main ways: fiscal policy or monetary policy.  The most successful economies stem from governance where these two are in sync, or at least not counterproductive.  An example of monetary policy is the Federal Reserve Board’s Quantitative Easing, or QE.  Examples of fiscal policy are austerity programs implemented in the European Union.  Faced with a global economic downturn, contrary to other major economic powers the US Government chose to flood the market with capital rather than pursue austerity.  As a result, the US Economy has fared better than our European brethren; so much so that the United Kingdom has begun QE as well.  Now, though, the effectiveness of QE has begun to wane, and many are wondering why.

Why haven’t there been larger reductions in unemployment? Why are corporations holding onto excessive amounts of capital rather than investing? Why has consumer confidence only seen modest gains? Why has housing begun to level off after some modest gains? The only truly bright spot has been the growth in the stock market, which has as much to do with profitability as QE, and falters the minute the Fed begins to indicate an easing of QE.

The short answer to all of these questions, the absence of fiscal policy has been counterproductive to the point where the monetary policy may begin to harm the economy.  The ineptitude in Congress creates uncertainty for producers, consumers, investors, lenders and borrowers.  Come 01 October 2013, Congress will not have passed a budget for the fourth year in a row.  This is their main job!  Some in Congress are threatening a Government shutdown.  Even if there is a Continuing Resolution, the Government will only be funded two and a half months instead of the full year.  Some in Congress are threatening the full faith and credit of the US Government by not raising the debt ceiling. While Government spending is related to the debt ceiling, the debt ceiling is for money that has already been spent.

Consumer spending and business investment drive the US Economy.  Businesses are not investing because demand has not returned.  Consumers are not spending to protect themselves from the uncertainty coming out of Washington, and mortgage rates which have increased in no small part due to the potential of a US Government default.  Investors are shying away from the bond market for fear their investments will be undercut by a Government default.  All of this slows the velocity of money, and with it the economy as a whole.  Without decisive action from Washington, the US Economy is stuck in the chicken vs. egg paradox.

Not only has the lack of fiscal policy caused its own harm to the US Economy, but now it is causing harm to monetary policy and the credibility of the Fed itself.  After signaling an impending taper to QE, the Fed decided to keep the program in place.  In large part, the reason for this change is an attempt to push past the chicken vs. egg paradox. 

Unfortunately, monetary policy cannot do this on its own.  And what is worse, as the Dallas Federal Reserve Bank President Richard Fisher correctly points out, this turnabout degrades the credibility of communications coming from the Fed. To compound matters, Mr. Bernanke’s impending retirement creates uncertainty for monetary policy.  No disrespect to the candidates vying to succeed him, but markets dislike change.

Without decisive fiscal policy, monetary policy will become less and less effective at stimulating the economy.