Paul Krugman: staying the course

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.

  1. 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.
  2. 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.
  3. 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).
  4. 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.

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7 Responses to Paul Krugman: staying the course

  1. Joshua Gans says:

    I think you mean Robert Lucas.

  2. Fred Argy says:

    Thank you, Joshua. I have now rectified the error.

  3. Thinking in old ways says:

    “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”

    While I can accept that economic modeling can provide a good case for a certain outcome I think that citing it as “ample proof” is overstating the case a little (especially when trying to forecast outcomes a decade down the line in a very uncertain environment).

  4. Fred Argy says:

    Thinking in old ways,

    Fair point too. I should have been more cautious.

  5. “This is exactly what the Rudd and Obama Government have done by nominating a reasonably plausible long term scenario.”

    The point is that they cannot be credible. No more than a country without a central bank with some heft could be credible about future inflation fighting or a country without a court system could be credible about maintaining the rule of law. That’s why we need to build institutions to deliver what you say and I agree we need – a credible commitment to wind back the fiscal stance at the right time. If we don’t do that, fiscal policy will be neutered and we’ll go through another political cycle like the last one – over the last couple of decades when fiscal policy got a bad name because governments couldn’t show any discipline.

  6. Patrick says:

    I agree, I can’t imagine how a government could be credible in discussing the policies of its unknown successor in an unknown environment.

    But whilst I am slightly warmer on your idea of institutional fiscal constraints, I am about as skeptical as ever about your chance of getting them!

  7. Tel_ says:

    … over the last couple of decades when fiscal policy got a bad name because governments couldnt show any discipline.

    Benjamin Franklin:

    When the people find they can vote themselves money, that will herald the end of the republic.

    It’s been a long standing problem of Democracy that the time horizon of the voters is shorter than a lot of the things you would want to be able to achieve. However, the design of Democracy is not to achieve good decisions, it is to keep people alive and discourage civil war, political cleansing, etc. Think of it as a least-worst outcome.

    In a similar vein, forcing government to balance their budget in the short-term does at least give a guarantee that really bad things can’t happen, even though it might prevent some good things from happening. Least-worst reasoning. Then again, if we used gold as currency, there would be no way for governments to raise money other than tax and/or loans, so then they would just have to learn a bit of discipline and everyone would be comfortable that this was the case for now, and for all time (until someone figured out how to print gold, probably not something to worry about just yet).

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