It's the (real) economy, stupid!

Bill Clinton’s mantra was, “It’s the economy, stupid.” Today’s mantra should be “It’s the fiscal policy, stupid!”

Instead, Washington and the Fed are fixated on using expansionary monetary policy. But they’re ignoring their real tool for boosting the economy — fiscal policy. In fact, they’re pursuing contractionary fiscal policy — cutting the deficit rather than stimulating the economy. The real economy is in trouble, but we’re only stimulating the financial economy.

We need government spending that puts people to work or keeps them employed, like aid for states and towns so they don’t have to lay off school teachers. Instead, we’re getting even looser monetary policy. It’s not working, and Marshall Auerback explains why:

Recent speeches by the Fed suggest that they are indeed laying the groundwork for such a return to quantitative easing, or “QE2” as the markets are now calling it. It’s not the name of a ship-liner: quantitative easing essentially means that the central bank buys up high yielding assets and exchanges them for lower yielding assets. The premise is that the central bank floods the banking system with excess reserves, which will then theoretically encourage the banks to lend more aggressively in order to chase a higher rate of return. Not only is the theory plain wrong, but the Fed’s fixation on credit growth is curiously perverse, given the high prevailing levels of private debt. More borrowing is the last thing the highly stressed and leveraged American household requires today.

As we have argued many times in the past, credit growth follows creditworthiness, which can only be achieved through sustaining job growth and incomes. That means embracing stimulatory fiscal policy, not “credit-enhancing” measures per se, such as quantitative easing, which will not work….

What is required to drive lending is a creditworthy borrower on the other side of the bank lending officer’s desk, which means an employed borrower, whose income allows him to sustain regular repayments. Absent that, there will be no lending activity.

Posted by James on Thursday, August 05, 2010