Paul Krugman has an article on the need to stay the course –
Paul Krugman makes a few telling points against the proposition that Obamas fiscal package now needs to be gradually pulled back.
- The Fed is raising the monetary base: does this risk a resurgence of inflation? The monetary base nearly doubled in the period 1929 to 1939 but prices fell 19 per cent. The same thing happened when Japans monetary base increased by 85%: deflation continued apace. Surplus reserves can be taken out as quickly as they were added once the recovery is well on course.
- The rise in government borrowing is simply offsetting the plunge in private borrowing. Total borrowing is down, not up, and it is not affecting foreign debt. This has been forcing down short term interest rates.
- One reason for the recent rise in long term interest rates reflects increased confidence that the depression can be avoided (producing a more normal spread between long and short interest rates).
- But the interest rate rise also reflects a degree of misplaced confidence in a quick recovery. Unemployment is still too high and its way too soon to declare victory. When this fact is realized, long term rates will be bound to fall back a little.
Krugman backs the claim of another Nobel prize winner, Robert Lucas.
Lucas argues that we need to be concerned about inflation and interest rates in the future, but right now the recession is the more immediate problem.
Krugmans view also agrees with The Economist, that a sudden fit of fiscal austerity would be a mistake —even counter-productive. Instead of slashing their deficits now, the rich worlds governments need to promise credibly that that they will do so once their economies are stronger.
This is exactly what the Rudd and Obama Government have done by nominating a reasonably plausible long term scenario.
In the meantime, there is ample proof that total employee incomes will, as a result of the fiscal package, increase over the next 10 years by $100 billion and the higher incomes should then deliver an extra $23 billion of tax revenue into government coffers (as reported by Swan). In other words, our ultimate debt levels may actually turn out to be smaller than they now are. (Our fiscal stimulus will still provide a stimulus even if encourages saving. Treasurys analysis indicates that people need some time to get back to their normal (optimal) levels of saving.
Add too that the Rudd Government is merely following the Howard principle of balancing the budget over the economic cycle and that our overall debt levels (net worth) will be small relative to other countries.
Some people may not like, for ideological reasons, the big government style of this government but the Government has got the policy about right.