Paul Krugman tells us not to worry about the medium term; Jeffrey Sachs tells us not (just) to worry about the short term; John Maynard Keynes tells us not to worry about the long term. What’s a body to think?
This morning in the New York Times Paul Krugman explains why we should only be concerned about the short term consequences of the fiscal stimulus plan. He specifically dismisses concerns about the medium term:
It’s not a problem if some or even most of the stimulus arrives after the official recession, as determined by the NBER, is over. Why? Because in modern recessions, unemployment keeps rising long after the NBER has determined, based on things like industrial production, that the recession proper is over. You can see that the need for stimulus doesn’t end with the recession by the simple fact that in each of the last two recessions the Fed continued to cut interest rates long after the official cycle trough. if it’s good enough for the Fed, it’s good enough for fiscal policy.
So what is the right criterion? Actually, I think it’s quite straightforward. The reason we’re talking about fiscal policy is the fact that monetary policy is up against the zero lower bound. Stimulus will still be valuable as long as we’re still up against that bound — which is likely to be the case for a long time.
Again, I think it’s helpful to look at the last two recessions, even though we didn’t hit the zero bound either time. The 1990-1991 recession officially ended in March 1991; but the Fed kept cutting rates, and it didn’t start raising the target rate until Feb. 1992, 2 years and 11 months later. The 2001 recession officially ended in Nov. 2001; but the Fed kept cutting, and didn’t start raising rates until June 2004, 2 years and 7 months later. This suggests a long window, even after the recession officially ends, before the zero bound stops binding, and hence before the current strong case for fiscal expansion goes away.
Suppose, for example, that the recession ends this summer (which seems wildly optimistic). If recent experience is any guide, the Fed will still be keeping rates at zero 2 1/2 years later, that is, at the end of 2011.
Which brings me to the CBO report, which presents spending profiles in terms of fiscal years (which begin Oct. 1 of the previous calendar year). Given what I’ve said, any spending that comes in fiscal 2009, 2010, or 2011 is good, and it’s no tragedy if some of the spending trails off into the years following.
Contrariwise, Jeffrey Sachs, writing at the Financial Times cautions against ignoring the medium term implications:
The most obvious problem with the stimulus package is that it has been turned into a fiscal piñata – with a mad scramble for candy on the floor. We seem all too eager to rectify a generation of a nation saving too little by saving even less – this time through expanding government borrowing. First it was former US Federal Reserve chairman Alan Greenspan’s bubble, then Wall Street’s, and now – in the third act – it will be Washington’s.
The White House and Congress have stated an amount – $825bn to be spent mostly over two years – on top of a deficit that is already projected to reach $1,186bn in fiscal year 2009 without the stimulus package. Many of the details of allocating the $825bn are being left to Congress with the aim of reaching a bipartisan consensus. The result is shaping up to be an astounding mish-mash of tax cuts, public investments, transfer payments and special treats for insiders.
What we need is a medium-term fiscal framework, one that lays out an anticipated schedule of taxes and spending consistent with the needs of the economy and government functions. Rather than soundbites about ending pork-barrel projects or scouring the budget for waste, or about the relative multipliers of tax cuts versus spending increases (both of which depend on expectations about the future, a point mostly overlooked in the debate), we should be reflecting on certain basic fiscal facts, the most important of which is that the US government faces huge and potentially debilitating structural deficits as far as the eye can see.
And, of course, John Maynard Keynes advised us that in the long term we are all dead. What’s to worry about?
In any complex system one of the toughest things to account for is friction. That’s true whether we’re talking about a mechanical system, politics, or the economy. Perhaps I’m just unobservant but it seems to me that economists are strongly inclined to discount friction completely.
In the fiscal stimulus plan making its way through Congress friction takes many forms. One of the forms is the amount of time the plan will take to be enacted; another of the forms is the amount of time that some of the measures will take to have any effect whatever on the economy.
Another form that friction takes in the fiscal stimulus plan is the efficiency of the measures that make it into the actual plan that gets enacted. The plan that Congress passes and President Obama signs into law will not be the perfect fiscal stimulus plan. A perfect fiscal stimulus plan is like a perfect gas: it’s something that exists only on paper and is never found in nature. There’s always some friction, turbulence, or randomness involved.
The key question is whether a fiscal stimulus plan that will actually be passed by Congress and signed into law will be effective enough to have a notable effect on the economy in the short term without its medium term implications, as noted by Jeffrey Sachs, being overwhelmingly damaging. These are practical, real world questions and can’t be answered on the basis of pure reason.
Paul Krugman tells us not to worry about the medium term; Jeffrey Sachs tells us not (just) to worry about the short term; John Maynard Keynes tells us not to worry about the long term. What’s a body to think?
I guess you’re stuck having to listen to this guy, then. Sure it’s sappy, but the advice is at least as practical as anything the (macro-)economists will tell you. Economics ain’t called the Dismal Science for nothing.
Krugman writes: You can see that the need for stimulus doesn’t end with the recession by the simple fact that in each of the last two recessions the Fed continued to cut interest rates long after the official cycle trough. If it’s good enough for the Fed, it’s good enough for fiscal policy.
I have three issues with this.
First, didn’t the low interest rates that persisted well after the end of the last recession contribute to the housing bubble, which is a primary cause of our current recession?
Second, if Fed policy after the last recession contributed to the current cirsis, then Krugman’s second sentence doesn’t sound terribly convincing.
And the third issue also concerns the second sentence I quoted. Is it necessarily true that fiscal policy and monetary policy can be considered to work in exactly the same way in this case?
Also, a typo: The third Krugman paragraph should have the date as Feb 1994, not Feb 1992.