The increase in the US GDP growth in the second quarter of 2009 has generated hope that the worst of the financial crisis is over. Consequently, there is a feeling that the fiscal stimulus package in the USA, should be withdrawn. Is it really time to do so? Many economists have argued that the current increase in the US growth rate is a result of the fiscal stimulus. Hence, any withdrawal of the stimulus now might induce the US economy to relapse into a downturn.
This is not merely a conjecture. History lends credence to this view. President Roosevelt�s New Deal introduced during the Great Depression led to recovery between 1933 and 1936. Its premature withdrawal in 1936, led the US economy back into a recession. Something similar happened to Japan in the1990s. A slowdown in 1991 prompted the Japanese government to introduce fiscal stimulus. This helped the economy recover at a moderate pace. However, a cut in government expenditure in 1996 saw Japan slip back into a recession.
The withdrawal of fiscal stimulus this time round may have the same effect. This is because other growth stimuli in the form of higher consumption expenditure or interest cuts have limited scope in the US economy. The main stimulus for growth in the US economy before the crisis was rapid consumption growth, financed by debt.1 With the onset of the financial crisis the credit market froze resulting in a reduction of consumer credit and a consequent cut in consumption demand. The growth rate of personal consumption expenditure in the US was -1 per cent in Q2 2009.2 Moreover, in Q2 2009, consumption credit declined by 6.6 per cent.3 These figures indicate that there has not been a revival in consumer demand as yet in the US.
Moreover, unemployment in US is still on the rise. The unemployment rate increased from 7.6 per cent in January 2009 to 9.7% in August 2009. Employment in non-agricultural sectors declined by 216000 in August 2009, while the total number of unemployed persons increased by 466000.4 In August, the real weekly earnings of non-agricultural workers declined by 0.2 per cent as compared with the preceding month.5 The continuing job losses and fall in workers� real earnings are likely to accentuate the demand problem.
However, falling consumption demand and real wages is not a sufficient condition for continuing with the fiscal stimulus. It can be argued that a boost to private investment expenditure through a reduction in interest rates would do just as well to revive the economy. But the scope for any further reduction in the interest rate is limited. The rate at which the Fed lends to commercial banks, has been reduced from 6.25 per cent in January 2007 to 0.5 per cent at present. The massive reduction did not do much to stimulate the economy.
In short, the current situation of the US economy is such that it must continue with a fiscal stimulus to fully recover from the recession. The main argument against continuing such fiscal stimulus is that it raises the real interest rate, which crowds out private investment. However, the inflation-adjusted, 10-year constant maturity treasury rate actually declined from 2.75 per cent in October 2008 (immediately after the crisis) to 1.77 per cent in August 2009. In other words, even with high government expenditure, there has been no increase in real interest rates in the US economy.
This analysis makes it apparent that Keynesian policies of higher public investment can provide the answer to handling a severe downturn in demand.