Harvard Economist warns of a second slowdown in US

Courtesy : Moneycontrol

Martin Feldstein, Professor of Economics at Harvard University, warns of a second slowdown in the US. "I am not predicting that we are going to have a double dip, but I think it's a significant risk."

He feels the Obama administration is not doing anything to deal with the fundamental problems of small and regional banks, availability of credit, and potential defaults on mortgages and on commercial real estate. "There is too much focus instead on health legislation and not enough on real problems."

Here is a verbatim transcript of an exclusive interview with Martin Feldstein on CNBC-TV18. Also watch the accompanying video.

Q: What do you think of the fact that they have been able to come up with this bank tax proposal so quickly to fix a problem that’s a perceptional problem? I understand there is politics involved. Whereas the very same administration has for sometime now been dragging its feet on doing anything about reforming or changing the financial regulatory system which is actually where the bigger problem lies?

A: Absolutely right but those are very simple proposals. The regulatory issues are very complex. Congress may not go along with this tax but it’s certainly very simple to describe and it’s something that the public can understand while the regulation of bank capital or leverage ratios that’s a very complex issue.

Q: Since it’s a symbolic gesture like you pointed out to be able quell public anger and mistrust of large Wall Street entities. Do you also think it’s symbolic in some sense of governments trying to fix the wrong problem?

A: This year the big problem was clearly the economy, it was the housing sector, it was the small and medium size banks and they really haven’t fixed those problems. President has focused virtually all of his political attention on the healthcare issue, which amazingly the majority of the public has now come around to saying to the pollsters, “We prefer what we have to and what the Congress has come up with.”

Q: Across the world everybody is very keen to understand when America will come back into poll position because it has driven the global economy for so long. Earlier this month you were quoted as saying “There is a significant risk and the economy could run out of steam sometime in 2010.” Are you warning of a double dip and you also been quoted saying “I do not think the Obama administration is doing anything to reduce that risk.” Are you warning of a double dip and if yes then what would you like to see the Obama administration do to be able to avoid it or evade it in some fashion?

A: I am warning a bit. I am not predicting that we are going to have a double dip but I think it’s a significant risk because it’s very easy to see the negatives in 2010 and it’s hard to see whether it’s going to offset it adequately. The administration is not doing anything to deal with the fundamental problems of the small and regional banks, the availability of credit, the potential defaults on mortgages and on commercial real estate, too much focus on health legislation and not enough on real problems.

Q: You backed the first stimulus plan even though you have been critic of its efficacy and its ability to solve the real problem. Are you in favour of second one as what the administration said?

A: What I backed was the idea that there should be one. What the President then did was to turn to the Congress and say to them to go design it. What came out was not very good.

However, I am certainly not in favour of another one because I am afraid that if we had another one it would so frighten financial markets and individuals who would just be seeing the national debt growing faster and the deficits growing faster that it would undermine confidence. This will make it harder to get the economy going. So we would more than lose through reduced confidence anything that would be gained from the direct impact of spending.
Q: What do you propose the Obama administration does?

A: If they do something to reduce the out-year deficit, not this year and next year but 2015 and beyond, if they put some changes in place that will boost confidence that will make businesses feel that interest rates are not going to go through the roof. The taxes aren’t going to be raised so if they can do that that will help. They have to work on the problem of the residential and commercial real estate where the fact that we are going to see continued defaults, continued foreclosures, a lot of property being put on the market hangs as a cloud over the banks.

Hence, the banks are cutting back on their lending. Therefore, small and medium enterprises are not able to get the credit they need to expand. So they got to deal with that taking some of those bad assets off the bank books and improving the quality of those real estate loans.
Q: Isn’t that just more government in the banking system, something that most economists and free market thinkers are so totally opposed to?

A: I do no think it is of more government in the banking system. We need to find a way of reducing the problem of loans which are going to default. It will cost government money but I would rather see that than to see these downward spiral in house prices, real estate prices hurting the banks. So if I look at the pluses and minuses, something has to be done in that direction.

Q: The first suggestion that you made was to be able to reduce the deficits of out-years that is. the years further on like you mentioned the fiscal 2015, 2016. How are they able to do that? What are some of the measures that you would like to see because we are expecting some sort of budget announcement in February and though that document may not address something as farsighted as that but it might have some suggestions?

A: It does because the way the budget comes out is it has a tail plan for year one. It also lays out things that are going to affect fiscal deficits for whole decade. If you look out over the current decade, government spending is a share of gross domestic product (GDP) is projected to rise from something like 21% to 26%. Hence, they are going to look at those increases and say, do we really need those, could we cut back on some of those and if they do that then we can bring down the size of the fiscal deficits.

Q: You think that this is an important priority that the government must attend to because there are an equal number of economist across the world who say while the fiscal deficit is just a number, the bigger problem in American right now is unemployment and trying to help that problem would mean even more government spending? We have two polarised views here – more government spending, second stimulus.

A: I think that dealing with the out-year fiscal deficit because of its impact on confidence and peoples expectations about future tax hikes would actually deal with the current employment situation. This will stimulate economic activity today in a better way than increased government spending.