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Summers: Economy Needs More Fiscal Stimulus

Monday, 07 Jul 2008 02:37 PM

The credit crisis and economic downturn could get worse without more fiscal stimulus, warns former Treasury Secretary Lawrence Summers.

In a recent opinion piece in the Financial Times, Summers, now a professor of economics at Harvard, aurges regulators to take preemptive measures including passage of the housing aid bill, moves to stem commodity price increases, and preparations for failure of another large financial institution.

“It is quite possible that we are now at the most dangerous moment since the American financial crisis began last August,” Summers writes.

“Staggering increases in the prices of oil and other commodities have brought American consumer confidence to new lows and raised serious concerns about inflation.”

That inflation, which has now surpassed 4 percent, is “limiting the capacity of monetary policy to respond to a financial sector, which — judging by equity values — is at its weakest point since the crisis began,” Summers maintains.

“With housing values still falling and growing evidence that problems are spreading to the consumer credit sector, there is a possibility that a faltering economy damages the financial system, which weakens the economy further.”

That’s why more fiscal stimulus is necessary, Summers says.

“With long-term unemployment at recession levels, there is a clear case for extending the duration of unemployment insurance benefits,” he argues.

“There is now also a case for infrastructure investment, as financial strains have distorted the municipal credit markets to the point where even the highest-quality municipal borrowers are, despite their tax advantage, paying more than the federal government to borrow.”

To be sure, the U.S. should be careful not to push its budget deficit out of control, Summers says.

“Fiscal stimulus measures must be coupled to budget process reform that provides reassurance that once the crisis passes, the fiscal policy discipline of the 1990s will be re-established.”

As for the housing bill, “while it is an imperfect vehicle,” Summers acknowledges, “it would contribute to the repair of the nation’s housing finance system. Failure to pass even this minimal measure would undermine confidence.”

On the subject of spiraling price increases, Summers says, “the primary source of inflation concern is increases in the price of oil, food and other commodities.” Steps he favors include:

  • “Reform of misguided ethanol subsidies that distort grain markets to minimal environmental benefit, allowing farm land now being conserved to be planted.”

  • measures to encourage the use of natural gas

  • reform of Strategic Petroleum Reserve policy to encourage swaps for when the market is indicating short supply.

    Finally, “It needs to be recognized that in the months ahead there is the real possibility that significant financial institutions will encounter solvency problems as the economy deteriorates,” Summers writes.

    “Regulators should do what is necessary, including possibly seeking new legislative authority, to assure that in the event of an institution becoming insolvent, they can manage the resolution in a way that protects the system while also protecting taxpayers.”

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    The credit crisis and economic downturn could get worse without more fiscal stimulus, warns former Treasury Secretary Lawrence Summers.In a recent opinion piece in the Financial Times, Summers, now a professor of economics at Harvard, aurges regulators to take preemptive...
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    Monday, 07 Jul 2008 02:37 PM
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