Global Recession Concern Spurs Governments to Boost Spending

By Simon Kennedy

Oct. 23 (Bloomberg) -- After easing the financial-market panic by committing trillions of dollars to shore up their banking systems, governments are broadening their focus to buffering its economic aftershocks.

U.S. lawmakers are moving toward the second fiscal stimulus bill this year and Japanese Prime Minister Taro Aso is set to cut income taxes. In Europe, Britain's Gordon Brown plans to spend more on schools, Italy's Silvio Berlusconi looks to enact tax breaks for manufacturers and Angela Merkel of Germany mulls tax rebates. Emerging-market countries from China to Thailand are also lining up new initiatives.

``Having taken action on the banking system, we must take action on the global recession,'' Prime Minister Brown told U.K. lawmakers yesterday. ``No country can insulate itself.''

Politicians are acknowledging the worst still lies ahead for their economies and their own electoral fortunes unless they act to cushion growth. World leaders will meet in the U.S. on Nov. 15 to review progress in combating the financial crisis and how to avoid a repeat of it.

The cost of borrowing money among banks has fallen after authorities in the U.S. and Europe acted to take stakes in their biggest banks as global stocks plunged and lending seized up. The London interbank offered rate, which banks charge each other for lending dollars overnight, yesterday fell to 1.12 percent, the lowest since June 2004. It reached a record 6.88 percent on Sept. 30. The three-month rate for dollars dropped for an eighth day.

`Meltdown' Averted

``A global meltdown has been averted and governments, while implementing their respective rescue plans, should now turn their attention to the economy and limit the effects of a global recession,'' said Geoffrey Yu, a London-based currency strategist at UBS AG.

Tensions are easing too late to prevent companies and consumers from retrenching. Economists at Deutsche Bank AG expect the Group of Seven economies to contract 1.1 percent next year, the worst since the Great Depression. Even with emerging markets lending support, they predict the weakest global growth since the 1980s.

``As growth slumps, fiscal policy should turn sharply expansionary,'' said Thomas Mayer, Deutsche Bank's co-chief economist in London.

U.S. lawmakers are devising new spending plans after Federal Reserve Chairman Ben S. Bernanke endorsed the idea on Oct. 20 and the Bush administration dropped its opposition. The new push will aim to extend jobless benefits, fund infrastructure projects and help cash-strapped regional governments, according to House Budget Committee Chairman John Spratt.

Fading Fillip

The effect of measures totaling $168 billion that U.S. lawmakers passed in February has faded after they gave the economy a fillip in the second quarter.

Aso, with an election nearing, will next week unveil the government's second stimulus program since August. The plan will probably include income-tax cuts, deductions for people with home loans and an extension of breaks on capital gains, say economists.

European governments may bend their own rules that cap budget deficits in a bid to save their economies.

Brown's U.K. government will next month step up spending on housing, energy and small businesses, while bringing forward construction projects on schools and hospitals, say ministers including U.K. Chancellor of the Exchequer Alistair Darling.

Italian Prime Minister Berlusconi's government is indicating it will enact tax breaks for carmakers and appliance manufacturers. German Chancellor Merkel, who had focused on returning her budget to balance, is considering a 15 billion-euro ($19.3 billion) package of tax rebates.

China Tax Cuts

Emerging markets, the growth engines of the global economy, are also looking for remedies to fading expansions.

China's State Council on Oct. 21 cut taxes for exporters and approved construction programs including new expressways and hydro-electric power stations. Thailand's Deputy Prime Minister Olarn Chaipravat and Jun Kwang Woo, chairman of South Korea's Financial Services Committee, said in separate interviews on Oct. 21 that their governments may ease fiscal policy.

Governments may prove more powerful than central bankers in the current environment, said Julian Jessop, chief international economist at Capital Economics Ltd. Lower interest rates are less effective when the financial system is frozen and have a lagging effect at the best of times, he said.

Fewer Obstacles

Governments also have fewer obstacles than usual, Jessop said. Public borrowing is unlikely to ``crowd out'' other spending given that consumers and companies are cutting back, while the inflationary byproduct of budget deficits will offset deflationary forces such as cheaper fuel and rising unemployment, he said.

``The greater use of discretionary fiscal policy will be an increasingly important global theme over the coming year,'' said Jessop, a former U.K. Treasury economist.

There are some barriers to how far governments can go, and in the longer term investors may punish those running the largest budget deficits, said Robert Lind, chief economist at ABN Amro NV. He calculates that among rich countries Finland, Sweden, Luxembourg and New Zealand have the greatest capacity to spend, while the U.S., U.K. and Japan have the least.

The U.K. this week posted its biggest six-month budget deficit since World War II, while the annual deficit in the U.S. could exceed $1 trillion for the first time. In contrast, economies which have enjoyed commodity booms such as Australia or China have budget surpluses and currency reserves to tap.

For now, Lind said governments are rightly invoking the spirit of economist John Maynard Keynes, who died in 1946 after a career advocating activist government as the best solution to slumps such as the Great Depression.

``More government intervention should help to contain the severity of the economic downturn,'' said Lind. ``We are all Keynesians now.''

To contact the reporter on this story: Simon Kennedy in Paris at Skennedy4@bloomberg.net