Vicious circles

Vicious circles

The stimulus packages that the United States has been pursuing since 2008 have not yet been able to stimulate enough household expenditures in the country. Federal Reserve Bank chief Ben Bernanke has warned that Congress must act as quickly as possible to solve the budget impasse to reduce taxes and further increase public spending. Otherwise, he implies, another recession is inevitable.

However, all these measures might also fail to convince people to spend more.

For some European countries that have deficit and debt problems, there is no intention of encouraging people to spend more. On the contrary, the leaders of the eurozone, which promised to help troubled countries, forced the governments in those countries to advise abstinence – that is, austerity measures. However, some other countries, especially the U.S., are all trying to convince people that spending more is the only way to cure the maladies of unemployment and insufficient growth, but the measures have remained ineffective. Which policy recommendation is contrary to past experience?

The reference point is again, of course, John Maynard Keynes. He had the courage to point out a very simple fact which other prominent economists refrained from saying then and refrain from saying now: Cutting public spending in a depressed economy depresses that economy further. This is a well-known vicious circle which appears during every serious economic crisis when slashing spending and raising taxes are advised. This is the case in Europe now.

The U.S. problem is quite different. Since the beginning of the crisis, authorities have tried to stimulate the economy through more public spending and tax cuts. However, both unemployed and employed people have chosen to keep the stimulus packages’ extra monetary advantages in their pockets for the unknown future instead of spending more. This is the same for private business, which is hesitant about making new investments even if the interest rate is close to zero. This is the vicious American circle.

Another important point is people’s reaction to the new things offered by the stimulus packages. This reaction could be called the elasticities of spending against things like interest rate cuts and tax reductions. If initial interest rates are comparatively very low and the tax rates are again comparatively quite moderate, further cuts in interest and tax rates might not induce extra spending.

In short, when people are unhappy about the present situation and uneasy about their future, it is quite difficult to convince them to spend more. Even some people who have guarantees for their future might think that it is shameful and perhaps sinful to spend mindlessly when some of their relatives, friends and neighbors are jobless or penniless. This was the case among common people, especially in the U.S. during the 1929 crisis, and it was understood that changing that behavior was more difficult than convincing Congress to solve the budget impasse as soon as possible.

European Central Bank chief Mario Draghi has promised to use his power to print money, which means the bank might undertake massive purchases in eurozone markets. This promise gave investors hope and created an optimistic climate in financial markets. Last week, however, he dashed hopes that the ECB would take imminent action. Before that meeting, he said the bank would act “if the region’s crisis worsens.”

There is a well-known anecdote in Turkey: A man is asked to taste two bottles of wine and decide which one is worse. The man takes a sip of the first one and immediately pronounces that one to be the worse of the two. Asked how he could know that that wine was worse without even tasting the other, he replied: “No wine could be worse than that.”