| News Nov 2010 US Economy and mid-terms Module |  |  |  | |
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The US economy and the mid-term elections |
It is a worn phrase that the economy decides elections. While the recession can hardly be blamed on the current administration or Congress, incumbents always suffer at mid-term and especially so if Main Street America is suffering. And with a 9.6% unemployment rate, economic suffering and anger is in ample supply now.
It is less often the truth that elections decide economic outcomes. While the state of the economy is often blamed on politicians, and while politicians are often willing to take the credit in good times, the truth is that cyclical economic policy is rarely very different whoever sits in Congress and in the White House. To be sure, there are political fault lines in the US when it comes to distributional issues such as who should get lower taxes or whether the public sector should grow or shrink. But when addressing a recession all US presidents turn activist and Keynesian in their attempts to appear proactive, to deliver the jobs and to keep their own.
However, in reality fiscal policy rarely matters much for the economy. The phrase among economist is that the Central Bank “draws last”. That is, the tighter the fiscal policy and the weaker the economy, the more interest rate cuts the Federal Reserve will deliver, effectively balancing the impact of fiscal policy in the end. And if the administration and Congress overdose, the Federal Reserve knows what to do, too.
That is, until now. With US monetary policy rates at the zero rate floor, the Federal Reserve is now forced to do “quantitative easing”. These are untested instruments, and the risk is that they are largely ineffective. If so, fiscal policy is crucial for once. There might not be a Federal Reserve to draw last this time.
This is why the fate of the Bush tax cuts matters. This is why this election for once can tilt the medium term outcome for the US economy in one or the other direction. With the Tea Party movement surging in the Republican party, populist anti-federal sentiment is on the rise. This is understandable in terms of the economic pain suffered. But in the current circumstances it could create a gridlock in which Congress ends up doing nothing on the fiscal front. Per default this would mean a significant fiscal tightening next year. Without any monetary easing, the risk will be that the recovery falters. In that case the tightening might not even improve the fiscal situation much. | | |
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