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Obama seeks $310 billion in tax cuts

US President-elect Barack Obama is seeking as much as $310 billion in tax cuts as part of a massive stimulus plan to counter what senior policymakers warned could be a prolonged period of economic stagnation and deflation.

Obama's plan is the latest in a series of measures aimed at tackling a financial crisis that began with US mortgage defaults in 2007 and has now plunged major economies into recession, reshaped the banking landscape and taken entire countries to the brink of bankruptcy.

Over the weekend, both Janet Yellen, president of the San Francisco Federal Reserve Bank, and Lucas Papademos, vice president of the European Central Bank, highlighted the risks of deflation - an economically damaging spiral of falling prices and demand.

Investors have, however, begun to make tentative bets that the worst of the turmoil triggered in September by the collapse of investment bank Lehman Brothers is over.

Kicking off the first full week of 2009, they pushed up stocks, the dollar and commodities while selling safe-haven plays such as government bonds and the Japanese yen.

Elsewhere there were signs of greater stability. South Korea, one of those countries that appeared to be on the brink of financial collapse, said its foreign exchange reserves rose in December for the first time in nine months.

Helping increase the appetite for riskier assets, senior Democratic aides said Obama planned to discuss his tax cut and stimulus package plans with Democratic and Republican leaders of the Senate and House of Representatives on Monday.

The tax relief proposals are designed to attract support from fiscal conservatives in Congress, who prefer cutting taxes to increasing federal spending.

Under Obama's proposal, about 40% of an economic package worth as much as $775 billion would be in the form of tax breaks for businesses and the middle class, one aide said.

The US economy is in need of drastic measures. US jobs data at the end of the week are expected to show half a million jobs were lost in December alone, pushing the unemployment rate to 7%.

“The financial and economic firestorm we face today poses a serious risk of an extended period of stagnation - a very grim outcome,” Yellen, a voting member of the Federal Open Market Committee in 2009, said.

“I'm strongly supportive of a substantial fiscal stimulus package,” she said at the annual meeting of the American Economics Association on Sunday.

“If ever, in my professional career, there was a time for active, discretionary fiscal stimulus, it is now.”

Even with the Fed's efforts to restore credit flows, an extended period of economic weakness was likely, she added.

Yellen also said the Fed would likely expand its raft of unconventional monetary policy measures now that its benchmark rate has hit rock-bottom. The Fed's target rate is between 0.25% and zero.

The ECB's Papademos, meanwhile, said that more interest rate cuts may be needed to support the euro zone economy and keep deflation at bay.

“We will do what is necessary, in terms of the timing and in terms of the size (of interest rate policy action) to ensure that price stability is preserved,” he said.

Central banks elsewhere are rushing to reduce interest rates to historically low levels.

The Bank of England is expected to cut interest rates to 1.25% this week, taking its base rate to the lowest since the BoE was founded in 1694.

Central banks in South Korea and Indonesia are also expected to lower borrowing costs again this week.

Since hitting multi-year lows in November, stock markets have responded positively to the flood of money pouring into the system from central banks and governments.

Tokyo's Nikkei average ended a shortened session up 2.1%, while stocks elsewhere in the Asia-Pacific region gained 1.4%, hitting a two-month high.

Oil prices gained 1.8%, while base metals such as copper and zinc also rose on expectations of a recovery in industrial demand.

Still, some analysts cautioned against expecting a rapid rebound in economic growth.

“It took more than three years for the economy to recover from both the dot.com bust of 2000 and the stock market crash of 1929,” Merrill Lynch's US economist David Rosenberg said in a note.

“So, in our view, hopes that the economy is going to recover as soon as mid-year are likely to be dashed in coming months.” (Reuters)