Paul Krugman’s column in today’s Times travels some of the same terrain trod by Robert Reich late last week, offering a concise rebuttal to the deficit/inflation hawks and a compelling defense of public investment as the b est way out of our current economic mess.
Krugman says that “the deficit worriers have it all wrong” and that “strong fiscal expansion would actually enhance the economy’s long-run prospects.”
The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates, which makes businesses unwilling to spend on new plant and equipment, and that this in turn reduces the economy’s long-run rate of growth. Under normal circumstances there’s a lot to this argument.
But circumstances right now are anything but normal. Consider what would happen next year if the Obama administration gave in to the deficit hawks and scaled back its fiscal plans.
Would this lead to lower interest rates? It certainly wouldn’t lead to a reduction in short-term interest rates, which are more or less controlled by the Federal Reserve. The Fed is already keeping those rates as low as it can — virtually at zero — and won’t change that policy unless it sees signs that the economy is threatening to overheat. And that doesn’t seem like a realistic prospect any time soon.
What about longer-term rates? These rates, which are already at a half-century low, mainly reflect expected future short-term rates. Fiscal austerity could push them even lower — but only by creating expectations that the economy would remain deeply depressed for a long time, which would reduce, not increase, private investment.
Krugman offers some historical parallels — the mid-point of the Great Depression, Japan in the 1990s — that offer glimpses into what happens when “tight fiscal policy” becomes the overriding approach during a harsh downturn: Reduced public investment “reduces private investment.”
What made fiscal austerity such a bad idea both in Roosevelt’s America and in 1990s Japan were special circumstances: in both cases the government pulled back in the face of a liquidity trap, a situation in which the monetary authority had cut interest rates as far as it could, yet the economy was still operating far below capacity.
And we’re in the same kind of trap today — which is why deficit worries are misplaced. One more thing: Fiscal expansion will be even better for America’s future if a large part of the expansion takes the form of public investment — of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.
Krugman is not advocating for a “permanent policy of running large budget deficits,” but rather for policies to reverse the “fundamental shortfall in private spending” that is tethering us in place.
Hank Kalet 