How time flies. Just over a year ago, economists and politicians of all stripes rediscovered their inner Keynesians and started calling for a massive global stimulus effort to head off the financial crisis. They got what they asked for — a US$3-trillion spending bonanza, including Ottawa’s $62-billion stimulus plan, matched by a full frontal attack on interest rates around the world. Today, most developed countries have returned to growth. But if there was consensus about the need for stimulus, opinion is deeply divided over what will happen when government intervention comes to an end.
It may seem out of place to be talking about the end of stimulus when so many countries are still expanding their bailout programs. Japan just announced another US$81-billion injection into its moribund economy. Meanwhile, Washington is gripped by a debate over whether to administer a second dose of stimulus, even though the effects of the first will still be felt for at least two more years. Yet countries like Australia and Canada, which both dodged the worst of the recession, have signalled the end is near. In December, Finance Minister Jim Flaherty warned the provinces they have only until Jan. 29 to commit to stimulus projects, and that the projects must be completed by March 2010, or the federal money evaporates.
But even if global stimulus spending doesn’t end this year, in 2011 or even 2012, its contribution to overall growth will start to dwindle. That raises the critical question of whether the private sector is ready to fill the gap. “The unwinding of stimulus means the private sector will have to be able to fully take the reins of economic growth,” says Beata Caranci, director of forecasting at TD Economics. “We’re in no man’s land here, because we’ve never had interest rates at zero, or the central banks in the U.S. and U.K. pushing billions of dollars into the markets. There’s a lot of potential for error.”
The good news is that in Canada, at least, there are signs the private sector is reasserting itself. Caranci points to strong consumer spending, the housing market and a rebound in business confidence. In November, private businesses began hiring again, adding 57,000 new jobs. The resilience of businesses may be put to the test in June, when the Bank of Canada’s moratorium on interest-rate increases expires. But Caranci believes the bank still has a year before it has to get serious about raising rates.
The bigger question is whether the United States, our most important trading partner, can remain upright once the crutches of stimulus are removed. On the surface, the evidence isn’t promising. Over the past year, Washington has unveiled several bailout programs targeted at specific sectors of the economy. Yet in each case, the affected industry relapsed once government support ended. For example, the Obama administration’s Cash for Clunkers program paid Americans US$3 billion to scrap their old cars and buy new ones, but after a sharp spike in auto sales, car and truck sales plunged again. More worrisome is that the only new jobs in America are in the public sector, like health care and education. More than seven million U.S. jobs have disappeared over the past two years, and there are few signs companies are ready to rehire.
The situation worries Paul Volcker, the former Federal Reserve chairman and an economic adviser to the White House. “We have not yet achieved self-reinforcing recovery,” he said in a recent interview. “We are on a government support system.” Fearing a double-dip recession as the effects of stimulus start to wane, Nobel-winning economists Joseph Stiglitz and Paul Krugman have urged Washington to prepare a second economic adrenalin shot on the scale of last year’s US$787-billion stimulus measure.
Others worry another, more troubling scenario is taking shape. They argue that the decision by the Federal Reserve to slash interest rates to zero, and then flood capital markets with liquidity through quantitative easing, has sown the seeds for a spike in consumer prices and years of sky-high inflation. At the very least, they say, U.S. officials are simply inflating another bubble. “It’s a phoney recovery,” says Peter Schiff, the president of Euro Pacific Capital (and a Republican senatorial candidate this year), who points to the stimulus-induced recovery that followed the dot-com collapse and the 9/11 attacks. “When the effect of that stimulus wore off, we experienced withdrawal, the collapse of the housing bubble, the bankruptcy of our financial institutions, and the worst recession since the Great Depression. Now we’re repeating the same mistake on an even grander scale, and it’s going to have even more disastrous results.”
Both post-stimulus scenarios — a double dip after a modest recovery, or another full-blown crisis after yet another bubble — leave a lot to fear, though the second would be far worse. But there is a third possible outcome. The private sector may do exactly what it’s supposed to do in a recovery: get back to business.
One reason for hope is that the economy is already on the mend, even though only a small part of announced government spending has gone out the door. In the U.S., only about 20% has been allocated for projects. In Canada, despite all the claims from Ottawa that 97% of stimulus funds have been committed, the money hasn’t actually been spent. As Niels Veldhuis, director of fiscal studies at the Fraser Institute, has pointed out, government spending and capital investments in the first half of ’09 were down significantly from the same time the year before. In effect, the recovery came without much government help.
Whatever scenario plays out, stimulus programs have left a deep and lasting mark on the global economy. Many nations face the largest deficits since the Second World War, and the only way out will be deep spending cuts and huge tax hikes. Last month, Prime Minister Stephen Harper warned Canadians to get ready for five years of belt-tightening, while promising no new taxes. We’ll see about that in another year.