<>Listener: 7 March, 2009. <> <>Keywords: Macroeconomics & Money; <> <>We face two conflicting messages over how to behave in current economic circumstances. One is that we should continue to consume and invest. If we don’t, spending and in production will fall, workers will be laid off, investment will taper off, the economy will contract, and we will find ourselves in deep -trouble. <> <>We are also being urged to improve our balance sheets by reducing the amount we owe. The economy has far too much debt, much of which is not matched by assets – for example, consumer debt and mortgages on overvalued properties. We cannot get back to sustainable growth until it is eliminated. These are uncertain times, and you don’t want to be too much in the red in case you lose your job. <> <>However, saving to reduce debt means spending less, which accelerates the downwards spiral of a contracting economy. This is “the paradox of thrift”; what is good for you may not be good for the economy. <> <>This column does not give investment advice, but for what it’s worth, I am paying attention to my balance sheet, eliminating imprudent debt. When my balance sheet is strong I may spend, especially on those quasi-investment items I will have to purchase in the next few years anyway. For example, it might be time to get the house painted. <> <>About a year ago, the Government had a strong balance sheet. Over the past ten fat years, I advocated controlling spending and running fiscal surpluses because I wanted the Government to be ready for the lean times we are now in (although I did not expect the economy to get this dire, this quickly). Rightly – in my view – the Government has weakened its balance sheet to maintain spending in the economy. We won’t have a comprehensive review of the state of the government accounts before the May Budget, so I have to read the tea leaves. <> <>The impression I get from the Prime Minister’s statements goes like this: the already committed fiscal injection – tax cuts and additional spending – is big by international standards. John Key seems to be indicating the injection may be so large that making it any larger may compromise the future. (A credit downgrade would raise the interest rates on our overseas borrowing – which would affect those households and firms that are in debt.) He seems to be saying, albeit cautiously, that the Government would be reluctant to increase the fiscal injection further. <> <> <>On the margin, government – and indeed private – borrowing is funded offshore, so a critical issue is the willingness of overseas lenders to stump up the cash to fund that bit of our spending that exceeds our income (in addition to rolling over existing borrowing). Eventually the gummed up financial markets will loosen and fund prudent borrowing. But when? And will they judge our borrowing prudent? <>The overseas monetary authorities – especially the US Federal Reserve – have spent 18 months trying to ungum the world’s financial system with barely a glimmer of success. We await impatiently to see whether US Treasury Secretary Tim Geithner’s package – designed to stress-test and then bail out (or even take into public ownership) America’s 14 largest banks – will work. <> <>The ungumming is going to take time. Its problems are horrendous – how to value toxic assets? Will it be necessary to nationalise the banks? How to do it without enriching those who got us in the mess at the expense of the taxpayer? Will it stop the depression train before it runs over us? <> <>Together, the financial bail-outs and massive fiscal injections in some of the largest economies in the world – the US, Japan, China, Europe – could reverse the international economic contraction by the end of the year. But if the money markets open up only slowly, their fiscal injections could be in funding difficulties too, and we could be years off the -recovery phase of the cycle. I’m pessimistic: Key seems more optimistic – I hope he’s right. <> <>What both of us are certain of is that the consequences are going to gum up his premiership – and this column – for some time. <>