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Economic Policy Out of Ammunition

The major problem with the economy is that consumers are not spending as a result of the record household debt built up over the last few decades. Until this huge amount of debt is pared down to more normal levels, fiscal and monetary policy can do little to return the economy to previous growth rates. It is therefore misguided to blame the lack of growth on uncertainty about excessive regulation, tax policy and health care. It’s all about the debt.

No matter what we do about regulation, taxes or health care, consumer spending will necessarily remain under pressure. Corporations are not hiring because they know that consumers are unable to absorb any additional products and services. Consumers are not borrowing since they want to reduce debt, not increase it further. Banks are reluctant to lend since they have mortgage debt on their books representing millions of homes that are underwater.

Household debt as a percentage of disposable personal income has averaged about 75% since 1952. It moved above that level in the mid-1980s and kept going until it reached as high as 130% at the peak of the housing boom. It has since declined back to about 114%, still far above any level prior to 2005. Even getting back to the 1987 level of 75% would restrain consumer spending for many years to come.

It has taken massive fiscal and monetary stimulus to engender the weak economic recovery experienced in the nearly two years since July 2009. We have seen TARP, the early 2009 stimulus act, cash for clunkers, tax rebates for first-time home buyers, near-zero interest rates, QE1, QE2 and other programs too numerous to mention. Despite these policies, the recovery has been the weakest of the post-war period and now shows signs of petering out with no new growth catalyst in sight.


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