The Economist warns against using fiscal stimulus to pull America out of its current slump:
The last time the Federal Reserve slashed interest rates to shore up the economy, between 2001 and 2003, it sowed the seeds of today's housing mess. Although a housing and credit collapse would be deflationary, pre-empting that risk too dramatically could be inflationary. Consumer prices are rising uncomfortably fast, and people's expectations of future inflation, by some measures, have inched upwards. If central bankers allow inflation expectations to become unhinged, they will have a nasty, protracted problem on their hands. That is why the Fed's measured pace of interest-rate cuts is prudent.
If America's economy falls into a long slump, then of course politicians should grasp the fiscal lever. That is one way to reduce the pressure for extreme monetary easing. Cash-strapped consumers in depreciating houses might respond more forcefully to tax cuts than lower interest rates. And if the mortgage mess gets bad enough, a public bail-out—say by using institutions such as the Federal Housing Administration—may prove a less damaging palliative than heavy-handed government rewriting of mortgage contracts.
But none of this means it is right to act now. With private spending weakening, not slumping, there is no case for a fiscal offset. Although America's budget deficit, at 1.2% of GDP, is not enormous, the room for manoeuvre is smaller than in 2001, when Mr Bush sold his tax cuts as a stimulus. Partly as a result, Congress is contemplating only modest actions—such as a tax rebate, more food stamps, perhaps some infrastructure spending. It is likely to be a vain exercise: unnecessary if the downturn is mild, but insufficient to deal with a truly dire mess. Like good doctors, policymakers ought to plan for the worst. But, for now, they should keep their strongest pills locked away.
It's safe to say that as memories of the 1970s have faded, the Federal Reserve has become a little less hawkish than it used to be. Is it too loose? I'm not sure. In hindsight, Y2K didn't wipe us out, and the economic impact of the 9/11 attacks was limited, so the Federal Reserve probably erred too far on the easy side. But of course, in hindsight, I should have staked my life savings on Giacomo to win the 2005 Kentucky Derby.
Nor am I clear on how much of the stock/housing bubbles should be laid at the Fed's feet. For all that the market drops whenever the Fed fails to provide ever-easier credit, I need a better explanation than a mild loosening in the late 1990s for why the stock market soared to such exotic multiples of historical values.
That said, it is now clear that inflation is ticking upwards: not yet to worrisome levels, but enough to make one fret that today's price increases may be a harbinger of worse to come. I went to one of my favorite Ethiopian restaurants last night and was handed a newly printed menu with prices about 10% higher than the old ones. Like today's core inflation numbers, this is not in itself particularly notable--except that it called to mind my dim memories of menus in the 1970s, when prices changed so fast that many places didn't bother reprinting the menus, but merely stuck new stickers over the old prices.