[Skip to the end]
> (email exchange)
> On Tue, Sep 29, 2009 at 11:20 AM, Joshua Davis wrote:
> moving in the right direction for sure, but for partly
> the wrong reason…he still misses the point that we’re
> not on a gold standard…
Yes, very much so. Does not seem like it would take much to set him straight.
If anyone on this list knows him, please email him a copy of ‘the 7 deadly frauds’ thanks!
By Paul Krugman
Sept. 29 (NYT Blog) — As I get ready for the CAP and EPI events, Iâ€™ve been thinking more about the issue of crowding in. (See also Mark Thoma.) And Iâ€™m coming more and more to the conclusion that the public debate over fiscal stimulus, which views it as an agonizing tradeoff between possible benefits now and certain costs later, is wildly off base.
Just to be clear, weâ€™re talking about fiscal stimulus in a liquidity trap â€” that is, under conditions in which conventional monetary policy has lost traction, in which the Fed would set interest rates much lower if it could. Under more normal conditions the conventional view of stimulus is more or less right. But weâ€™re in liquidity-trap conditions now, and will be for a long time if official projections are at all right. So what does that imply?
First of all, as I and others have pointed out, fiscal expansion does not crowd out private investment â€” on the contrary, thereâ€™s crowding in, because a stronger economy leads to more investment. So fiscal expansion increases future potential, rather than reducing it.
And yes, thereâ€™s some evidence to that effect beyond the procyclical behavior of investment. The new IMF analysis of medium-term effects of financial crisis finds that
the evidence suggests that economies that apply countercyclical
fiscal and monetary stimulus in the short run to cushion the
downturn after a crisis tend to have smaller output losses over
the medium run.
So fiscal expansion is good for future growth. Still, it does burden the government with higher debt, requiring higher taxes or some other sacrifice in the future. Or does it? Well, probably â€” but not nearly as much as generally assumed.
Hereâ€™s why: first, in the short run fiscal expansion leads to higher GDP, which leads to higher revenues, which offset a significant fraction of the initial outlay. A billion dollars in stimulus probably leads to only $600 million or a bit more in additional debt.
But thatâ€™s not the whole story. Crowding in raises future GDP â€” which raises future tax revenues. And the rise in revenues relative to what they would have been otherwise offsets at least some of the burden of debt service.
Iâ€™m not proposing a fiscal-stimulus Laffer curve here: itâ€™s probably not true that spending money actually improves the governmentâ€™s long-run fiscal position (although thatâ€™s certainly within the range of possibilities.) What I am suggesting is that fiscal stimulus under current conditions, where theFed funds rate â€œoughtâ€ to be around -5 percent, does much, much less to hurt that long-run position than the headline number would suggest.
And that, in turn, means that penny-pinching on stimulus is deeply, destructively foolish.