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Keep close watch after debt deal

Published: 02 Aug. 2011, 21:03

After much tension and suspense, Congressional leaders reached a bipartisan agreement Sunday night on emergency legislation to reduce government spending and raise the debt ceiling in an effort to prevent the United States’ first-ever financial default. To the relief of fragile markets around the world, including in the U.S., the dramatic deal came with scant time left before Tuesday’s debt-limit deadline to repay government bills. President Barack Obama announced that the deal will “allow us to avoid default and end the crisis that Washington imposed on the rest of America.”

The bill aims to raise the government’s $14.3 trillion debt limit by $400 billion and tame the country’s debt pile through sharp spending cuts over the next decade. Despite the increase in borrowing authority, the U.S. economy would begin tightening its belt, which will inevitably slow down the economy and send it to a double-dip contraction. The deal is more political than economic and provides little comfort to the U.S. and global economy.

U.S. gross domestic product grew at a disappointing 1.3 percent pace in the second quarter, and the U.S. economy has been staggering along since the second half of last year. Since the Wall Street meltdown in 2008, Washington has been driving the economy on two engines - expansionary fiscal policy and loose monetary policy. But financial bailouts and increased spending to fuel the economy has sent federal debt to levels unseen since World War II. The U.S. government earned leeway for borrowing into 2013, but is confined to stringent austerity to cut spending by $1 trillion over the next decade. It no longer can increase spending to boost the economy.

Monetary policy remains the only way to stimulate the economy. Authorities cannot lower interest rates from their current ultra-low base. But it still has the quantitative option of increasing money supply. It is a risky move with the consumer price index rising at 3.6 percent. The Federal Reserve could be blamed for worsening inflation. But authorities are prepared to take the risk if the economy heads for a double dip. Ben Bernanke, chairman of the Federal Reserve, recently told a Congressional committee on finance that another bout of easing could be necessary if the economy fails to regain momentum.

Another round of quantitative easing would further depress the value of the U.S. dollar and spark up inflationary pressure across the globe. The Korean economy would receive a blow from a stronger won and an uptick in prices. We have to keep close watch on U.S. economic news.