There is an easy way to re-inflate the economy. Just abate everyone’s income, business and payroll taxes for a year, two years, or even longer if necessary.
Policy right now has become a mad scramble to get money flowing through the veins and arteries of the economy. We have Congress passing huge spending bills that depend on fiscal deficits. We have the Treasury trying to convince us that securities based on existing mortgages are worth much more than everyone knows. We have the FDIC trying to convince us that people in distressed mortgages shouldn’t be allowed to default. And we have the Fed monetizing hundreds of billions of dollars’ worth of Treasury debt.
Why does all of this inflationary activity have no effect on prices? Because credit intermediation is still frozen at levels far below the norms of recent years. Inflation isn’t too many dollars; it’s too many dollars chasing too few goods. The roughly two-thirds of retail and business credit that has been being supplied by asset securitizations is now gone, and there’s no way for it to come back except at much higher interest rates. Which is to say, it won’t happen, because those higher rates cut against the logic of borrowing money in the first place.
We’re caught in a deflationary cycle which may or may not be every bit as bad as that of 1930-32. There’s no way to actually know that, because today’s monetary authorities, with Ben Bernanke at the head of the list, understand how important it is to counteract deflation. They’ve ginned up a gale of inflation, blowing in the opposite direction from the gale of deflation, and they’re roughly canceling each other out. (We are starting to see some asset bubbles begin to re-form, of course. Keep your eyes on oil and gold again, as well as U.S. Treasury debt.)
Everyone in Washington is looking for a magic bullet that will cause GDP growth to start spinning back up, so they can tell us the crisis is over. Well, GDP rose strongly nearly every year from 1933 until the start of World War II. Nominal GDP growth doesn’t mean an end to depressed conditions. It just means things could be even worse than they are.
What if it turns out that credit intermediation via asset securitization really doesn’t make a comeback? What if we have to start depending on banks again for credit? This is a plausible strategy, but it depends on increasing capital in traditional banks.
What’s an easy way to do that? Abate every single dime of income, business and payroll tax for at least a year.
This would produce fiscal deficits that aren’t much larger than the ones we’re already talking about; and they would be sustainable, on a percentage-of-GDP basis. The extra money not taken in taxes would find its way magically into savings accounts held by consumers. (Mainstream economists, of course, consider this a bad thing.) When it gets there, the money would automatically increase the capital levels of the banks that aren’t badly hamstrung with legacy mortgage portfolios. There are thousands of these banks in the U.S., many of them community or regional banks that have not been damaged by the crisis.
Many people fail to appreciate that the federal government doesn’t need to collect taxes in order to spend money. It prints its own money. In a fiat-money world with a very large government, the only economic reason to collect taxes is to control the overall inflation level. But today, the whole problem in the economy is deflation rather than inflation. The most direct way of counteracting it is to abate tax collections. So let’s declare a full federal tax holiday. And let’s give it a year or two or three to work. Private credit formation will come back and the economy will start growing again.