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Stiglitz: Rate Cuts, Stimulus Likely Ineffective
Nobel Prize-winning economist Joseph Stiglitz says the United States is headed toward a "liquidity trap” similar to events of the 1930s U.S. economy.
Essentially, long-term bond rates might fail to respond to short-term interest rate cuts enacted by the Federal Reserve.
If that happens, credit will stay tight and the Fed will have to admit it has lost control, Stiglitz told The Telegraph in Davos, Switzerland, at the World Economic Forum.
"We'll have the reverse of what we've seen in recent years, and that is what is frightening the markets," Stiglitz warned.
"The mechanism of monetary policy is ineffective in these circumstances. I'm not saying it won't work at all: it will help the banking system but the credit squeeze is going to go on because nobody trusts anybody else. The Fed is pushing on a string," he said.
Even if the Fed cuts end up getting some traction in the economy, it might well be too late to matter, Stiglitz said. The Fed cut interest rates by 75 basis points on Tuesday and meets again next week on Tuesday and Wednesday.
The first, surprise cut seems to have calmed markets down after several days of wild trading. But now investors could be pricing in another big move downward by the Fed – and setting themselves up for another round of panic selling if the Fed doesn’t comply.
In addition, rate cuts just won’t save the housing market, which is in freefall mode, nor will it replace the spending cash homeowners had been cashing out of their homes during the boom.
"People have been drawing home equity out of the houses at a rate of $700bn or $800bn a year. It's been a huge boost to consumption, but that game is now up,” Stiglitz said.
"House prices are going to continue falling, and lower rates won't stop that at this point," he said. Stiglitz, a former economic advisor to President Bill Clinton, said the stimulus package being rush through the Congress is probably too small at $150 billion, and is aimed at the wrong consumers.
"As a Keynesian, I'd say the biggest bang for the buck in terms of immediate stimulus would be unemployment assistance and tax rebates for the poor,” Stiglitz said.