I disagree. I believe there is a strong case for further stimulus. Admittedly, consumption cannot be sustained indefinitely by running up the national debt. The imbalance between consumption and investment needs to be corrected. But to cut back on government spending at a time of large-scale unemployment would ignore all the lessons learned from the Great Depression.
The obvious solution is to draw a distinction in the budget between investments and current consumption and increase the former while reducing the latter. But that seems unattainable in the current political environment. A large majority of the population is convinced that the government is incapable of efficiently managing an investment program aimed at improving the physical and human infrastructure. Again, this belief is not without justification: a quarter of a century of agitation calling the government bad has resulted in bad government. But the argument that stimulus spending is inevitably wasted is patently false: the New Deal produced the Tennessee Valley Authority and the Triborough Bridge.
It is the Obama administration that has failed to make a convincing case. There are times like the present when we cannot count on the private sector to employ the available resources. The Obama administration has in fact been very friendly to business. Corporations operate very profitably, but instead of investing their profits, they are building up their liquidity. Perhaps a Republican victory will give them more confidence; but in its absence investment and employment needs to be stimulated by the government. I do not believe that monetary policy can be successfully substituted for fiscal policy. Quantitative easing is more likely to stimulate corporations to devour each other than to create employment. We shall soon find out.
This brings us to the question I raised earlier. How much room does the government have for fiscal stimulus? How much public debt is too much? This is not the only unresolved question but it is at the center of political debate and the debate is riddled with misconceptions.
That is because the question does not have a hard and fast answer. In saying this I am not being evasive; on the contrary, I am making an important assertion. The tolerance for public debt is highly dependent on the participants' perceptions and misconceptions. In other words it is reflexive.
There are a number of variables involved. To start with, the debt burden is not an absolute amount but a ratio between the debt and the GDP. The higher the GDP the smaller the burden represented by a given amount of debt. The other important variable is the interest rate: the higher the interest rate the heavier the debt burden. In this context the risk premium attached to the interest rate is particularly important: once it starts rising, the prevailing rate of deficit financing becomes unsustainable and needs to be reigned in. Exactly where the tipping point is located remains uncertain because it is dependent on prevailing attitudes.
Take the case of Japan: its debt ratio is approaching 200%, one of the highest in the world. Yet ten year bonds yield little more than 1%. Admittedly, Japan used to have a high savings rate but it has an ageing and shrinking population and its current savings rate is about the same as the US. The big difference is that Japan has a trade surplus and the US a deficit. But that is not such a big difference as long as China does not allow its currency to appreciate because that policy obliges China to finance the deficit one way or another.
The real reason why Japanese interest rates are so low is that the private sector - individuals, banks and corporations - have little appetite for investing abroad and prefer ten year government bonds at a 1% to cash at zero percent. With the price level falling and the population aging, the real return on such instruments is considered attractive by the Japanese. As long as US banks can borrow at near zero and buy government bonds without having to commit equity and the dollar is not allowed to depreciate against the renminbi, interest rates on US government bonds may well be heading in the same direction.
That is not to say that it would be sound policy for the US to maintain interest rates at zero and preserve the current imbalances by issuing government debt indefinitely. Once the economy starts growing again interest rates will rise and if the accumulated debt is too big it may rise precipitously, choking off the recovery. But premature fiscal tightening may choke off the recovery prematurely.
The right policy is to reduce the imbalances as fast as possible while keeping the increase in the debt burden to a minimum. This can be done in a number of ways but cutting the budget deficit in half by 2013 while the economy operating far below capacity is not one of them. Investing in infrastructure and education makes more sense. So does engineering a moderate rate of inflation by depreciating the dollar against the renminbi. What stands in the way are misconceptions about budget deficits exploited for partisan and ideological purposes. There is a real danger that the premature pursuit of fiscal rectitude may wreck the recovery.
The obvious solution is to draw a distinction in the budget between investments and current consumption and increase the former while reducing the latter. But that seems unattainable in the current political environment. A large majority of the population is convinced that the government is incapable of efficiently managing an investment program aimed at improving the physical and human infrastructure. Again, this belief is not without justification: a quarter of a century of agitation calling the government bad has resulted in bad government. But the argument that stimulus spending is inevitably wasted is patently false: the New Deal produced the Tennessee Valley Authority and the Triborough Bridge.
It is the Obama administration that has failed to make a convincing case. There are times like the present when we cannot count on the private sector to employ the available resources. The Obama administration has in fact been very friendly to business. Corporations operate very profitably, but instead of investing their profits, they are building up their liquidity. Perhaps a Republican victory will give them more confidence; but in its absence investment and employment needs to be stimulated by the government. I do not believe that monetary policy can be successfully substituted for fiscal policy. Quantitative easing is more likely to stimulate corporations to devour each other than to create employment. We shall soon find out.
This brings us to the question I raised earlier. How much room does the government have for fiscal stimulus? How much public debt is too much? This is not the only unresolved question but it is at the center of political debate and the debate is riddled with misconceptions.
That is because the question does not have a hard and fast answer. In saying this I am not being evasive; on the contrary, I am making an important assertion. The tolerance for public debt is highly dependent on the participants' perceptions and misconceptions. In other words it is reflexive.
There are a number of variables involved. To start with, the debt burden is not an absolute amount but a ratio between the debt and the GDP. The higher the GDP the smaller the burden represented by a given amount of debt. The other important variable is the interest rate: the higher the interest rate the heavier the debt burden. In this context the risk premium attached to the interest rate is particularly important: once it starts rising, the prevailing rate of deficit financing becomes unsustainable and needs to be reigned in. Exactly where the tipping point is located remains uncertain because it is dependent on prevailing attitudes.
Take the case of Japan: its debt ratio is approaching 200%, one of the highest in the world. Yet ten year bonds yield little more than 1%. Admittedly, Japan used to have a high savings rate but it has an ageing and shrinking population and its current savings rate is about the same as the US. The big difference is that Japan has a trade surplus and the US a deficit. But that is not such a big difference as long as China does not allow its currency to appreciate because that policy obliges China to finance the deficit one way or another.
The real reason why Japanese interest rates are so low is that the private sector - individuals, banks and corporations - have little appetite for investing abroad and prefer ten year government bonds at a 1% to cash at zero percent. With the price level falling and the population aging, the real return on such instruments is considered attractive by the Japanese. As long as US banks can borrow at near zero and buy government bonds without having to commit equity and the dollar is not allowed to depreciate against the renminbi, interest rates on US government bonds may well be heading in the same direction.
That is not to say that it would be sound policy for the US to maintain interest rates at zero and preserve the current imbalances by issuing government debt indefinitely. Once the economy starts growing again interest rates will rise and if the accumulated debt is too big it may rise precipitously, choking off the recovery. But premature fiscal tightening may choke off the recovery prematurely.
The right policy is to reduce the imbalances as fast as possible while keeping the increase in the debt burden to a minimum. This can be done in a number of ways but cutting the budget deficit in half by 2013 while the economy operating far below capacity is not one of them. Investing in infrastructure and education makes more sense. So does engineering a moderate rate of inflation by depreciating the dollar against the renminbi. What stands in the way are misconceptions about budget deficits exploited for partisan and ideological purposes. There is a real danger that the premature pursuit of fiscal rectitude may wreck the recovery.
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