Search This Blog

Friday, February 27, 2009

Government's fiscal profligacy - can't have heads I win, tails you lose

Government recently announced another round of fiscal stimulus (indirect tax cuts) and it was followed by another round of criticism and concerns over spiraling fiscal deficit. Before the tax cuts, government was criticised for not providing any stimulus to the economy. Well, we cant have it both...

Either you provide stimulus to the economy (which would involve in varying degrees a combination of tax cuts or spending increases) or you worry about rising fiscal deficit. It cannot be a situation where if it provides stimulus (or attempts to) you criticise it for higher fiscal deficit and if it does not provide you criticise it for not doing enough for the economy.

The issue of fiscal deficit is important (I am by nature a fiscal conservative, would prefer very low or balanced government accounts) but we should not get uncessarily worried over high fiscal deficit. The problem of high fiscal deficit crowding out private investment or causing high inflation etc would arise only when the economy starts to recover.

If the basic hypothesis is that the current slowdown is very severe and unless the government provides the stimulus things will get far worse, then the current worry of slowdown precedes future worries of high fiscal deficit. The thought process then has to be lets first get out of the current crisis and worry about future crisis later on.

One can logically criticise the government on its state of finances only if the basis hypothesis is that either the growth deceleration is short lived and given the steps already taken growth will recover within a reasonably short time (3-4 quarters) by itself or that the growth deterioration is not severe enough to warrant the fiscal deterioration of the magnitude that we are seeing. Growth will slow from unsustainable levels (>9%) to more sustainable trend level and thus we should keep the house in order to be prepared for the next cyclical uptick. If this is not the basic hypothesis, criticism of the government on its fiscal profligacy is unjustified in my view...

No comments: