The assertion, “The deficit is our stimulus,” presumes that our economies are today suffering from the classic Keynesian deficiency of demand. That is far from being the case. Not a generalized deficiency of demand but a breakdown of confidence – this is what is causing industry to hold back on investment, it is what is causing even consumers to hold back on purchases. And that is precisely why cuts in rates of interest, cuts even in taxes are not triggering the surge in investments and purchases that policy makers have assumed would follow: how can the fact that a person will have to pay 2 per cent less as interest lead him to go in for a house when he is not sure whether he will have his job two months from now?

Prior profligacy limits a country’s ability to deal with the crisis. And profligacy today limits its ability to deal with the crisis as it continues into next year. Today the countries that have reserves, that have fiscal headroom, that have the ability to execute massive infrastructure projects – these are the countries that are in a better position to navigate the crisis. When investors and others see that their government is unable to bring its expenditures to heel, their confidence in the future is further damaged. And there is the real effect too: in India, with governmental borrowing of Rs. 3600 billion having become inescapable in 2009/2010, the State will be pre-empting the private sector from the market, it will be pre-empting the very sector on which it is coming to rely not just for executing infrastructure projects but even for financing them. A return to fiscal discipline, therefore, is necessary precisely for meeting the crisis.

... contd.