Sunday, October 24, 2010

Excellent defense of the Keynesian point of view on how to "prime the pump" of the economy..

This is an excellent defense of the Keynesian point of view on how to deal with an economy at less than full-employment. Notice it has MANY of the elements of Fiscal Policy we have covered recently in class and a couple we will cover this week, i.e. "the crowding out effect" of government borrowing.  It also provides an nice seque into Monetary Policy, which we will start in Week 11.  The script of the textbook is playing out on the stage of life so we can observe it, applaud it, or pan it...A bad time for the economy, but a good time for critical observers like me---and YOU! :)
NYTIMES: Now is not the time to cut the budget deficit by Christine Romer (former Obama Admin Chief Economist)
""THE clamor to cut the budget deficit is deafening.... Make no mistake: persistent large budget deficits are a significant problem. Government borrowing in good times crowds out private investment and lowers long-run growth.... So the question is not whether we need to reduce our deficit. Of course we do. The question is when.

Now is not the time. Unemployment is still near 10 percent.... Tax cuts and spending increases stimulate demand and raise output and employment; tax increases and spending cuts have the opposite effect. This is a basic message of macroeconomics and a central feature of public- and private-sector forecasting models. Immediate moves to lower the deficit substantially would likely result in a 1937-like “double dip” as we struggle to recover from the Great Recession.

Some advocates of austerity argue that, contrary to the conventional view, fiscal tightening now would lower long-term interest rates and improve confidence so much that the impact could be positive. But an ambitious new study in the World Economic Outlook of the International Monetary Fund confirms that fiscal consolidations — that is, deliberate deficit reductions — typically reduce growth.... The recent experience of countries already carrying out austerity measures is consistent with the central finding of the I.M.F. study. Ireland, Greece and Spain have all had rising unemployment after moving to cut deficits....

But once the economy has substantially recovered, the Federal Reserve will be ready to raise interest rates. At that point, the Fed could help maintain growth by instead continuing very low rates as the deficit is reduced. Waiting for conventional monetary policy to be back on line is like waiting for the anesthesiologist to arrive before doing surgery.

True believers might say we should never wait, because a slow-growing tumor could turn virulent. But we need to think about actual risks. Today, markets are willing to lend to the American government at the lowest 20-year interest rate since 1958. In the crisis of 2008 and 2009, money flowed to the United States because it was seen as the safest spot in the storm. There is no evidence that we have to act immediately.

Countries that enjoy the markets’ confidence have another reason to wait. Greece and other troubled nations on the periphery of the euro zone can no longer borrow at affordable rates. They must immediately cut expenditures and raise taxes, despite the terrible toll on employment and output. Countries like the United States, Germany and France can play an essential role as sources of growth and demand for the world economy. Strengthening our economies will help keep the world from slipping into another recession, and allow for continued healing of vulnerable financial markets here and abroad....

The best thing would be for Congress to pass a plan now that will reduce deficits when the economy is back to normal.... History shows that well-designed backloaded plans are credible. For example, changes to Social Security eligibility and taxes have been passed years, if not decades, before they took effect. And in an environment like today’s, when Congress has again agreed to pay-as-you-go rules, deviating from planned reforms forces countervailing actions. Such backloaded deficit reduction would not hurt growth in the short run — and could raise it. If uncertainty about future budget policy is harming confidence, as some business leaders suggest, spelling out future spending and tax changes could be helpful...""
HT: Grasping Reality with Both Hands
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