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3 truths on saving the economy

October 31, 2012

| MoneyRates.com Senior Financial Analyst, CFA

Some of the leading names in the financial industry released a letter to President Obama and Congress last week, urging them to take action to avoid the upcoming fiscal cliff. While the letter did not offer any specific solutions, it did underscore three truths about what it will take to save the U.S. economy.

Writing on behalf of the Financial Services Forum, the leaders of Goldman Sachs, Bank of America, JP Morgan Chase and several other large financial institutions called for a bipartisan effort to address the U.S. budget deficit responsibly. There are two elements to this. The first is avoiding the draconian fiscal cliff of tax increases and budget cuts due to take effect next year. The second is to put in place long-term measures to bring the deficit down over time.

The hard truths

Here are three truths about the budget crisis that the Financial Services Forum letter brings to the fore:

  1. The solution lies in fiscal, not monetary policy. Current mortgage rates are already at record low levels -- and unfortunately, so are rates on savings accounts and other deposits. In any case, the Federal Reserve has gone about as far as it can in its attempt to stimulate the economy with low interest rates. The letter cites comments from Fed Chairman Ben Bernanke last month that confirmed that no amount of monetary policy could negate the damaging economic effects of the fiscal cliff.
  2. The devil will be in the details. The letter is short on details, which may be a function of the fact that the letter was signed by 16 top executives. Getting such a large group to agree on a detailed proposal would have been much more difficult than getting them to broadly call for bi-partisan action. However, having such an influential group get behind some of the unpopular necessities that it will take to address the budget deficit might have helped provide some political cover for Congress and the president.
  3. Enlightened self-interest is the key. Though the letter avoided details, many in the financial community are on record as saying it will take a combination of entitlement reform and tax increases to adequately address the problem. While there are influential lobbies adamantly opposed to those changes, a little enlightened self-interest would create room for compromise. After all, younger people tend to be skeptical about there being anything left of Social Security by the time they retire, so why would they object to an increase in the eligibility age if that might keep the program solvent? As for taxes, there's a good chance that the wealthy would see their investments perform much better if a credible deficit-reduction program were put in place that it would easily compensate for a moderate tax increase as part of that program.

The reality is that it will take awhile for the dust to settle after the election before action can be taken. By that time, the fiscal cliff will be that much closer.

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