Higher spending lower taxes the key

IT IS universally acknowledged that the US economy will recover. This is equally true of Japan, but we are still waiting for recovery there 11 years after its bubble burst. So the inevitability of recovery is obvious rather than comforting.

Faith in an early recovery is based on interest rates falling until they do the trick. This is like relying on a politician's promise. Japanese rates have hit zero and the recession there gets worse. The US also had zero rates in the 1930s.

As an engine of recovery, lower interest rates often work - but not always. Over the past 50 years or so, they have worked in the US, where there is a dangerous tendency to ignore both the experience of other countries and the longer term at home.

We cannot know when lower interest rates will cause recovery unless we know why. Economists don't have one answer, they have several. The boost can come through a devaluation, higher investment or lower savings. None looks a likely winner today.

Fortunately, if lower interest rates don't do the trick, tax cuts or higher public spending probably will. Japan's recent experience shows that even this is far from guaranteed.

After the tragedy of 11 September, the need for both higher public spending and lower taxes seemed to be agreed. Republicans and Democrats disagreed only about which should take precedence. The politicians seem, however, to have quickly forgotten the common purpose. Meanwhile, the lobbyists have sniffed the heady scent of handouts. Every industry has its pet scheme for grabbing the public's money and every Congressman needs money for his campaign.

The spectacle is like the monkey trap - sweets in a bottle tied to the ground. Monkeys can't get their hands out unless they let go of the sweets. Greedy monkeys won't let go and get caught. In the end, no doubt, deals will be done and the corporate monkeys will smash the bottles and leave with the sweets. The result may be good for them rather than the economy. A spectacular example is the plan to repeal the AMT (alternative minimum tax) and repay money it has raised. This would put billions into corporate coffers but do little for the economy. Handouts based on the past only encourage more to be spent on lobbying.

While this unedifying process continues the economy suffers. Unemployment rose last month at the fastest rate for 21 years and even housing, which should benefit from lower interest rates, seems to be wobbling. www.smithers.co.uk