Economic Stimulus: Part 5 – Government Policy Options

Current United States government policies are inappropriate to the objective of ending the recession and starting a sustainable economic recovery. They are not directed at reducing the private debt-service to income ratio.

So what government policies might help people reduce their debt-service to income levels? The strategy is simple. Debts must be reduced, incomes must be increased, or some combination of the two.

There are three mechanisms to reduced debt service. (1) It can be paid down. (2) It can be refinanced at lower interest rates. Or (3), it can be repudiated. Two mechanisms could increase incomes. (1) Taxes could be cut to increase net incomes after taxes. Or (2), inflation could push up wages across the board.

For government policy to assist in paying down private debt the government would have to directly pay on the debt or provide additional money so people could pay down their own debt.

For government to increase private refinancing, government could reduce interest rates. However, many people who most need to refinance cannot because the value of their homes have fallen below the balance on their mortgages. In this situation, banks won’t write refinance mortgages. So, to affect this objective, government may need to purchase the current mortgages and reissue them at lower fixed interest rates. This might be accomplished through Fanny Mae, Freddie Mac, or even by the Federal Reserve Bank.

In order for government to increase debt repudiation the bankruptcy laws would need to be rewritten loosening the requirements for Chapter 7 bankruptcies. Or, the government might directly purchase bad debt from lenders and simply forgive the borrowers while writing the debt off the government’s books. This would probably be poorly received politically because of the perception of unfairness to all other borrowers.

For government policy to immediately increase incomes across the board tax cuts and tax rebates are the only tools available. Spending is too localized in its affects.

For government to increase nominal incomes broadly and continuously government could inflate the currency in a controlled and consistent manner.

Real government policy options for reducing private debt-service to income ratios are: (1) tax cuts and rebates; (2) buying private debt directly; (3) relaxing the bankruptcy laws; and (4) inflating the currency.

The United States government has cut the payroll tax slightly but is proposing income tax increases on high earners, the establishment of a new European style value added tax, and the imposition of carbon use taxes. These tax increases will have the reverse affect from what is needed. They will reduce net incomes and make private debt service more difficult.

The Federal Reserve has purchased some private debt in the form of mortgage backed derivatives; but they have no stated intention to forgive the debt or rewrite the terms at low fixed interest rates. Freddy Mac and Fanny Mae are offering somewhat helpful subsidized low fixed rate refinanced mortgages to borrowers who meet certain criteria. However, only a small fraction of at risk borrowers meets the criteria.

I’ve heard of no initiative to relax the bankruptcy laws. On the other hand, the government is doing everything possible to inflate the currency. The Federal Reserve is rapidly increasing the money supply and the Treasury is selling government debt overseas, repatriating dollars at rates unimaginable before it actually started happening. So far, the efforts to inflate the currency have been unsuccessful, but they will certainly succeed eventually.

Unfortunately, when the inflation begins it will drive up interest rates, slow the economy, and increase the cost of selling more government debt.

Current government policy is not helping to restart the economy.

Links to Other Topics in the Special Report: Economic Stimulus

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