May 07 2009
Learning From the Past…
“Aggressive monetary expansion plus aggressive fiscal policy equals economic recovery” 
Some examples from past seem to vindicate the above equation. The great depression in the U.S. caused a severe downturn between years 1929 and 1933. GDP collapsed by 26.5% and unemployment rose to 25% from mere 3%. Then it was followed by a relapse, between year 1937 and 1938 with 3.4% decline in GDP.
The first collapse was associated with equity bubble, protectionist tariff legislation, contractionary monetary policy and a sharp rise in tax rates. But the economy galloped thereafter leading to 9.5% p.a. expansion of GDP and a steep fall of 11 percentage points in unemployment rate.
Thanks to the monetary policy that was infused in. Between the years 1933-34 the dollar was devalued against gold to $35 per ounce from $20.67 per ounce, which allowed the Fed to push reserves into the banking system. The policy also bolstered the Fed to finance FDR’s deficits with the printing press. The consumer price index too unraveled its growth. The stock market that was horrendously down by 86.2% between September 1929 and June 1932, surged more than fourfold in five years and reached its peak in 1937. The increase in government spending also gave a push to German economy during 1930s.
So what about Japan that was plagued by equity and real-estate bubbles? Heavy government spending was paralleled by wasteful spending. It was also saddled by rise in tax rates. Japan certainly took a longer time to recover as it faces structural difficulties. Contrastingly, U.S. has robust liquidity growth and is far akin to Japan’s structural issues. So it may be possible for the economy to recover when aggressive monetary policy merges with aggressive fiscal expansion. The downturn may thus culminate by the year end and permeate into the growth stage of economic cycle by 2010. But to sustain such economic growth, it needs to overcome several other barricades including inflation.
-Sophia S Antonysamy
I don’t know if I agree with your assesment that agressive monetary policy combined with agressive fiscal policy = recovery.. To me that sounds like inflation, higher taxes and interest rates and the devalution of the dollar. Why would anyone want that for America? Wouldn’t it be better for the government to give the money back to the people and let the decide what they do with the money? Government spending is not as efficent as people their own money. Cutting taxes and shrinking government is the way to go in my opinion.
I certainly do not abide wasteful spending. Government’s useful spending coupled with pumping back money to people’s pockets would make some difference I believe. And, the intention of providing examples from past was to bring out the advantages as well disadvantages of monetary and fiscal policy that includes inflation and other drawbacks. And thus my last line says “But to sustain such economic growth, it needs to overcome several other barricades including inflation”.