Paul Krugman and Robin Wells have some prescriptions for U.S. policymakers to help them find “The Way Out of the Slump”:
… if you believe that deficit spending is an effective way to reduce unemployment … why not advocate going all the way and spending enough to restore full employment? Yet that is a recommendation few economists have been willing to make …
Krugman, himself, actually made that argument [PDF] in what he called “an ureadable little paper” back in December, 2008 in which he did what economists do with complicated models and lots of other stuff that was too much for me back when I was an undergraduate taking a second-year course in intermediate macroeconomics. So I'll trust that Krugman has his math right (or wait for others to tell me his math is wrong) because his diagnosis and prescription feel broadly right to me:
I went into the liquidity trap business believing that the concept of such a trap was nonsense – that you can always drive up prices by printing money. It wasn’t until I wrote down a very simple maximizing model that I realized that this was wrong, that a monetary expansion perceived as temporary may be entirely ineffective.. [and so] … when the economy is in a liquidity trap government spending should expand up to the point at which full employment is restored. That’s not a guess or a statement of personal preferences, it’s a result.
This is — I hope the point is obvious — more than just an academic argument nearly two years after Krugman published that “unreadable little paper”. The Canadian government is relatively firmly fixed on the idea that government spending will cease well before full employment is restored. (And by full employment, I mean where the unemployment rate is somewhere near structural levels and there are roughly the same number/quality of full-time jobs in Canada back as there was before the recession.) In Canada, our federal government and most provincial governments can certainly afford more spending in the sense that our debt ratios are, compared to eveyone else in the world, relatively low and that certain important tax-generating parts of our economy are holding up well.
Krugman and Wells, in the essay from this month that I'm about to quote extensively from, say that even the United States, seen by most as a financial basket case way over its head in debt, can, in fact, afford to spend more and, in fact, it ought to spend more to restore full employment. That advice, if taken, would be of tremendous help to its largest trading partner, Canada, and to many others in the developed world.
Krugman and Wells set out their prescription for policymakers by way of reviewing three new books about the current economic crisis. The one they appear to admire the most is Richard C. Koo's The Holy Grail of Macroeconomics: Lessons from Japans' Great Recession.
Koo…sees Japan as a qualified success story. In his view, the financial wreckage that occurred when Japan’s bubble economy of the 1980s burst could easily have led to a depression-level slump. Japan, however, managed to avoid that fate. The key, he argues, was those much-maligned budget deficits. Japan’s fiscal gap, he declares, “is a perfect example of a good deficit,” which sustained the economy while the private sector gradually restored its balance sheets to health. The only times Japanese policy went wrong, in Koo’s view, were those occasions when policymakers tried to return to budget orthodoxy, in each case setting off a new recession.
…But can governments really continue to borrow and spend? Yes, says Koo: like the world Keynes saw in the 1930s, today’s world is awash in savings with nowhere to go…
..This is, needless to say, a view very much at odds with the current conventional wisdom—but these days the conventional wisdom is looking very foolish.
Canada's prime minister Stephen Harper, who has a graduate degree in economics and did, to his credit, abandon ideology in favour of rational action at the beginning of the crisis, is now articulating this “conventional wisdom” in various international fora. Here is Harper in Davos, Switzerland, last spring:
We all know the long-term risks of prolonged government spending of this magnitude: renewed inflation, rising interest rates, crowding out of investment and prolonged sluggish economic performance.
Not true, say Krugman and Wells. Or at least, not yet.
Ever since the crisis began, establishment figures have warned that the bond markets are about to lose faith in nations with big budget deficits; yet interest rates keep falling rather than rising. At this point all of the major advanced-country governments can borrow long-term at an interest rate of less than 3 percent. These low long-term rates show that markets aren’t worried that current budget deficits will undermine the long-run fiscal viability of these governments. The low rates also suggest that there are no obstacles to a policy of supporting the economy with temporary deficit spending, whether that spending takes the form of investment in infrastructure, aid to the unemployed, or rebates to taxpayers . . .
Unconventional policies are as badly needed as ever; but policymakers have lost their nerve. Urged on by far too many policy intellectuals, they have reverted to conventional modes of thought.
The almighty markets, we’re told, will punish those who fail to impose harsh fiscal austerity even in the face of very high unemployment—even though, as we have noted, the reality of falling interest rates shows no indication that the much-feared “bond vigilantes”—investors who will stage a run on the debts of major nations, driving interest rates sky-high, unless deficits are brought down quickly—have any real existence. There is no sign that the US government, in selling bonds, will have trouble borrowing in order to finance deficit spending.
…Meanwhile, everyone seems to be ignoring the risks of allowing the slump to go on. The economic crisis that began in 2008 is by no means over. And if governments fail to act, the worst may be yet to come.
And remember — Krugman and Wells are talking about the U.S. Certainly, given Canada's substantially more healthy federal fiscal picture, there would seem to be less risk. So if our policy makers decided to spend their way out of this recession, then let's do it and actually spend our way out of this recession.