“In one sense, we are all Keynesians now …” When free-market economist Milton Friedman made this famous quote, he acknowledged the importance of government spending in offsetting economic downturns. A faltering economy needs cash to flow—like fuel through an engine. If that cash flow can’t come from private enterprise, government needs to step in. This is what Keynes concluded in the depths of the Great Depression.
If economists are, in some sense, all Keynesians now, politicians are not. The issue of stimulus spending has become political football. House members briefly returned from the summer recess to approve $26 billion in emergency aide for state governments. That is a paltry sum compared to TARP and Obama’s initial stimulus program, but don’t expect more. With the November elections approaching, debate over stimulus spending has become vitriolic.
No one at the Fed is fooled by the political posturing. Those guys are economists, which means—like it or not—they are Keynesians. Alarmed by the once-again deteriorating economy, not to mention Congress’s inability to act, they scrambled yesterday to find some means—anything!—to stimulate the economy. With short-term interest rates already close to zero, their options are limited. The best they could come up with yesterday was to start buying treasury bonds. One branch of government, the Fed, will essentially be lending to another, the Treasury. This is about as close as you can get to printing money. Noticeably, no one on either side of the political divide is complaining. The Fed doesn’t run for election, so they are off the radar screen.
The Fed’s spending will do little. Effective stimulus motivates spending on goods and services. Money spent on unemployment benefits or assistance to state governments tends to be spent immediately. It fuels recovery. Money spent on treasury bonds won’t have that effect. In normal times, it would tend to drive down interest rates, but interest rates are already low.
Here is another way purchasing treasuries might, in theory, afford some stimulus. By driving up treasury prices, it would make corporate bonds more attractive. Increased liquidity in that market might induce a few more corporations to issue new debt, the proceeds of which they might spend. That would stimulate the economy, but there is a problem. With investors skittish about the stock market, they are already shoveling money into corporate bonds. Yields are pitiful, but even marginal credits can issue bonds. The market doesn’t need—and won’t benefit from—treasury bond purchases.
Congress and the White House are hamstrung. The Fed knows there is an emergency, but they are pushing on a string. The rest of us can expect a grave economy, at least until after the November elections.