Scott Sumner neatly summarizes something close to my views on where we stand right now and how we got there:
I don’t doubt that a WWII-style military build-up would more than offset Fed policy conservatism. But what about politically plausible stimulus, say another $400 billion? I see the most likely outcome as a modest boost to the economy, which pushes up oil prices and headline inflation, which frightens the Fed, which leads the Fed to refrain from additional unconventional stimulus that they would otherwise do.
How do I know that the Fed would otherwise do more monetary stimulus? I don’t, but that’s certainly been their pattern over recent years, whenever the economy faltered. And there are already rumblings of the possibility of additional stimulus. And the number of hawks on the FOMC drops from 3 to 1 in January.
None of this means I’m right–as I’m no mind-reader. But if you look at how the Fed actually behaves, rather than what Bernanke says or “really†believes, then you are forced to conclude that the 2009 stimulus was sabotaged. That stimulus was not enough to create a robust recovery, even with unconventional Fed moves. If they hadn’t done that stimulus, it looks like the Fed would have done a more aggressive stimulus, as they seem determined to keep core inflation in the 0.6% to 2.0% range. And thus if we’d never done the 2009 fiscal stimulus, we’d probably be about where we are now–9.1% unemployment and 2% core inflation. But with a much smaller national debt.
I have made no secret that I have an abhorrence of debt. There’s a simple reason: low debt mitigates the risk of a variable income forcing you to change your lifestyle. As the interest on the debt rises, paying it absorbs more and more of your income. If it rises high enough, you’ve got to cut back in other areas.
But interest rates are low! (I hear somebody protest.) They will not stay low forever, how high they rise are not within your control (even if you’re the federal government), and when they do rise it can have a disastrous effect on even the most meticulously planned budget.
We may be entering a very new period in our history. For the last half century or more despite the many tax rate changes (or because of them!) federal revenues have maintained a remarkably constant 20% of GDP. If GDP remains flat or grows very slowly over time, either federal revenues must increase relative to GDP, we’ve got to constrain our spending to federal revenue, or we’ve got to borrow the difference indefinitely into the future. A very small difference every so often isn’t terribly concerning. I’m not a balanced budget crank. However, a permanent difference of 50% (or more) will inevitably bring ruin.
I favor the idea that we are entering a new era. We were able to rule the world after WWII while the rest of the world was in shambles. With Europe more functional and Asia joining the modern world, plus Brazil and few others, we managed another 20-30 years by increasing our debt. I think that we reached the limits of private and public debt financing and now face major choices about which way to go. I think that we are headed towards a two tiered society, the debate will just center upon how well the lower tier will live.
Steve