While there is consensus that we are in an economic malaise, there is little agreement on how to get the economy growing. I believe we can learn from a similar situation experienced by Japan during the 1990s.
Japan didn't bail out its troubled banking sector. As a result, it took nearly 10 years for its economy to exhibit growth - and only after it "primed the pump" with infrastructure investment. The U.S. has bailed out its auto industry, as well as banking and financial institutions deemed "too big to fail," and it has engaged in stimulus spending. Thus, the U.S. has increased its chances for a turnaround. However, like Japan, the Fed has kept interest rates near zero - and, like Japan, there's been no real growth.
Risks have not matched rewards.
In Japan, there was extreme risk, with over 20 of its largest financial institutions in technical default. That risk caused investors to shift money to Europe or the U.S., because Japan's interest rates didn't match the risk for domestic investments. Interest rates must rise commensurate with risk; if there's a disconnect between risk and return, investment doesn't take place.
In the U.S. today, corporations have $3 trillion more than they did in 2006, while banks are lending $4 trillion less. The money is there, but we have what John Maynard Keynes called a "liquidity trap," because of the risk-return gap is too wide.
There is more than enough cash in the coffers to stimulate the economy. However, when risk increases due to excessive deficit spending - which, during the 1980s resulted in increases of 1.5 to 2.0 percent in interest rates - investors expect a higher return. Yet, the U.S. is in its third year of near-zero returns on government securities, despite the rise in default risk.
So what is the solution? The nearly $6 trillion of funds available in corporate and bank treasuries are likely to be invested if the Fed signals its recognition of risk by raising interest rates at least 1 percent over the next six months. It should start with a half-percent increase, and smaller subsequent increments. A market interest rate of 2.5 percent is still historically low (the next-lowest period came during the 1950s), so the Fed can keep its promise to keep rates low through 2013.
Also, if our fiscal policy is aimed at creating jobs, then tax credits should be offered for new jobs, not for capital investment. There should be a direct connection between payroll and taxes; otherwise, people invest in processes that lower costs instead of those which stimulate revenues.
Tax collections rise only if revenues do. This could happen by giving a credit against the social security/Medicaid tax on new employees, which would improve a firm's cash flow and have an immediate impact, since payments are made quarterly. A skittish company won't invest until return matches risk, or when equilibration is likely to occur. With interest rates so low, there's only one direction they can go, but with risk increasing from high-deficit spending and no deficit-reduction plan in place, investors are sitting on the sidelines, waiting for rates to increase or for a plan from Congress and the White House.
Unfortunately for the many Americans currently out of work, our government is providing us with neither.
Dr. Russell P. Boisjoly is dean of the school of business and professor of finance at the State university of New York at Fredonia.