Friday, March 06, 2009

. Fiscal stimulus package: How effective can it be? (II)

Every country has different economic cycle pattern, which influences the economic tools to apply .New available macroeconomic models, integrate both fiscal and monetary policy, to evaluate the impact of a joint interaction to get the economy back on the stable growth path once a shock occurs, either from demand or supply side. On this regard, it appears a new element due to the volatility trade off. Thus, Lower output volatility imply higher inflation volatility. It follows that current fiscal policy packages which are mainly aimed at stabilizing output, imply the risk of higher inflationary pressures on the long term.-
Therefore ,Long run considerations , can not be ruled out within the framework of fiscal policy packages design when it comes to get over with such a shock .How significant can fiscal policy be to improve Productivity and competitiveness, is a good measure of those long run considerations included into the process. Short run impact of Fiscal policy, is stronger with infrastructure as long it deals with capital expenditures which has a strong multiplier effect. Building bridges, railroads and high way maintenance ,are positive for employment and growth . However, it is also feasible that within the public administration some conflicts might appears, due to the conflicting interest between managers with political ambitions, and government with political pressures on the rise about increasing unemployment levels affecting the channel of expenditure flows.
On the other side, Economics and politics can go along side by side quite well , when growth is the engine for financing redistribution, but when the economy get into recession , the redistribution demands increase and politics fall apart from economy. This imply a lesser degree of effectiveness of fiscal policy impact on growth ,as long as uncertainty because of political variables, become higher in such a situation . It might the case that the economy recovers despite fiscal policy packages, and not because of them.-
Monetary and fiscal policy coordination is specially relevant, when there is a higher risk of heavy losses on welfare levels, due to the magnitude of the economic contraction. This coordination, means a more efficient policy framework ,and a better controlled impact upon real variables. Strong fiscal policy reaction to an excess of revenue, induces a softer stand for monetary policy , (output and employment can keep stable ,and volatility is low),whereas a weak fiscal policy reaction to an excess of expenditure, imply a stronger monetary policy reaction(output and employment become unstable, and volatility is high). The issue deals with the trade off between output growth and price stability. A different matters arise when it comes to recession, when both instrument must be targeted simultaneously to lift up growth expectations and employment. More so, when monetary policy is trapped in a kind of liquidity trap which requires a strong financial policy to get the most from all the instrument applied .In a recent article, R Barro, (Wall Street Journal),analyzing the current situation of the US economy, suggest that the chance of getting the US economy into a severe depression is 20% .It follows that the combination of these policies in the US economy , have been able the get a 80% probability of avoiding depression, making possible an economic early recovery in the second half of this year, and a stronger one on the year 2010. Probably a better financial policy, would make that probability(to get away from depression) higher, and the prospect for economic recovery already at sight.