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Pre-election Policy Paralysis

Nothing that is done between now and the election can very much influence the economy’s performance

12:00 AM, Sep 11, 2010 • By IRWIN M. STELZER
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Meanwhile, the policy debate goes on. Some feel that the Fed should be more aggressive. Former Fed governor and now Princeton University professor Alan Blinder is suggesting that instead of paying banks interest on their $1 trillion in excess reserves, the Fed charge them for holding those reserves as an incentive to get them to lend rather than hoard funds. Blinder also thinks the Fed could give the economy a boost by persuading its risk-averse regulators to ease up on the banks because “some modest loans are not sinful, but rather a normal part of the lending business.” Others are hoping the Fed will set sail on QE2 – another round of quantitative easing, aka printing money.

Some prefer that the administration step up spending, and by a substantial amount, even at the expense of increasing the deficit, both because they fear a double-dip and because they believe the economy’s infrastructure is sorely in need of shoring up to support more rapid economic growth. Deficit hawks, seemingly backed by most voters, counter that until the government gets its fiscal house in order, and the president abandons his anti-business rhetoric, businesses will sit on their cash. They now have a new heroine, German chancellor Angela Merkel, whose refusal to countenance a massive stimulus, and who is bringing her already-low budget deficit down, presides over an economy that grew at an annual rate of almost 9 percent in the second quarter, and reduced the unemployment rate to 7.6 percent.

But anti-spending doesn’t mean anti-deficit in the tangled skein that is pre-election politics in America. At year-end the Bush tax cuts expire. The president wants to retain the lower taxes for all, save the rich – families with annual earnings of more than $250,000. His Republican opponents, and an increasing number of Democrats who fear raising taxes in the midst of a fragile recovery, want the cuts to remain in place for all, at least for 2011 and possibly 2012. Obama says the rich don’t need or deserve lower taxes, and that raising their taxes will help to reduce the deficit; his opponents say the geese the president sees right for the plucking include lots of small businessmen who will create fewer jobs if their taxes go up.

Meanwhile, the economy plods along on two tracks – the express lane for big companies, and the slow lane for smaller ones. In the financial services sector the big banks are doing just fine, while many smaller banks are unable to cope with the bad loans in their portfolios. In the industrial sector, large companies diversified into overseas markets are growing rapidly, smaller companies more dependent on domestic markets and with lesser access to credit are struggling.

All of which is the stuff that has investors confused, one day euphoric, the next day certain that the world as they know it is coming to an end. In the longer term, all might matter less than the fact that once past the election, America will have to decide what to do about its huge deficit, swollen when the health care bill takes full effect, about when the ageing baby boomers apply for their new hips. And, perhaps more lethal, America will have to decide what to do should China decide for geopolitical reasons to cash in some of its made-in-U.S.A. IOUs.

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