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Issue:
The issue at hand at this series of meetings is the effectiveness of President Obama’s
proposed recovery plan. Critics of the plan are anticipated to argue that the President’s stimulus
1. Monetary policy can reign in the business cycle better than fiscal policy.
Their Reasoning:
1. Monetary policy can reign in the business cycle better than fiscal policy
• In the paper “What Ends Recessions” Christina and David Romer’s findings show that
monetary policy has played a crucial role in ending recessions whereas fiscal policy has
• Fiscal policy was used in the 1960’s and 1970’s which only lead to high rates of inflation
and unemployment.
• Monetary policy is more flexible, it can be adjusted and re-adjusted in increments without
Congressional approval and there are fewer lags compare with fiscal policy. There is also
Our Response:
• It’s true that monetary policy can be effective at reigning in the business cycle, but it is
is to the lower bound of 0%. Since lowering the rates to their current levels hasn’t
restored liquidity in markets, it is hard to conceive that lowering rates by another 10-25
• The current recession wasn’t caused by the Fed increasing interest rates, so it can’t be
treated like other recessions. Instead it was caused by the drop in home values and
payments and the drop in home prices increased the Loan to Value of many mortgages to
as much as 130%, causing delinquency and foreclosure (Figure 1). Furthermore, since
banks had miscalculated the risk on securitized loans which were levered at ratios of
30:1, many banks are unaware of how much underlying risk they hold. Thus, increasing
monetary supply has been ineffective in restoring liquidity as banks are still unaware of
Figure 1:
Their Reasoning:
• According to the Federal Reserve the national debt is already above $10 trillion, and
running another large deficit as proposed by this stimulus plan will only create problems
o When we run deficits we have to have them financed by foreigners since our
savings rates are so low – ¾ of U.S. net investment is now from foreign capital
inflows
A large portion of this foreign capital is from foreign governments, whose
o According to Ball and Mankiw, budget deficits reduce national savings which
Our Response:
• It is important to realize that the stimulus package proposed by the President is a onetime
increase in the national debt and the President does not intend to run such large deficits
each year, but is doing so in order to respond to the current financial crisis.
• There is an advantage to running a large deficit – it will stimulate the economy through
to the current financial crisis, adding to the national debt on a onetime basis in
• It is still possible to grow our way out of the national debt. As long as the rate of GDP
growth is higher than the interest rate, the ratio of debt to GDP falls over time. Thus, the
that foreign governments will stop financing our debt amidst this recession. The recession
has been a global one, and since November the dollar has appreciated in value as other
countries have added more funds to the US economy. The US Treasury is still seen as the
safest investment and therefore the concerns of other countries not being willing to
• Though there are definitely legitimate concerns with running long term deficits, the large
Summary:
The current global financial crisis presents unique challenges that haven’t been present in
effective means at dealing with the stabilization of most business cycles, it has proven
ineffective in restoring liquidity in the market. There is little room for the Federal Reserve to
maneuver further with interest rates as low as they are currently and any further change is
unlikely to solve the liquidity crisis. Thus, President Obama has put forth a stimulus which
believe this measure is essential in order to avoid a prolonged recession and to revitalize the
economy.