Paul Krugman makes the case
for deliberately providing too much
of an economic stimulus. Here I want to examine the counter-case, for which I think there is a valid argument, although it doesn’t seem to be the argument that anyone is actually making. In the end, though, I agree with Professor Krugman: too much is better than too little.
Here’s the thing, though: there is one big advantage in doing too little economic stimulus. I mean, doing some, doing a significant amount, but not quite enough. The advantage (as I have argued in many of my recent posts) is that it doesn’t cost anything, because it can be financed with seignorage.
Professor Krugman makes the case that, from the point of view of the condition of the economy – the tradeoff between output and inflation, which is what macroeconomists usually care about – it is better to do too much, because, if you do too much, the Fed has the power to undo the excess by raising interest rates (whereas, if you do too little, there is nothing the Fed can do about it, since we’re in a liquidity trap). But as most people writing for the public acknowledge (or insist), there is more to care about than the condition of the economy. There is also the condition of the government’s finances.
As far as the government’s finances are concerned, it is not just a bad idea to do too much; it is a bad idea to do enough
. As long as you don’t do enough, standard textbook macroeconomic theory (at least the Keynesian kind, which is the one most influential among economic forecasters) says that there will be disinflationary, and ultimately deflationary, pressure. It’s a pretty simple point of logic. “Doing enough” is defined as getting the economy on a track where the unemployment rate will go down to the NAIRU (or possibly lower, if deflation takes hold and we are trying to reverse it). What other definition could there be? Then by definition of the NAIRU (the “non-accelerating inflation rate of unemployment,” which, if looked at from the other direction, is the non-de
celerating inflation rate of unemployment, or eventually the non-accelerating deflation
rate of unemployment), the inflation rate will tend to keep falling. Therefore, the Fed can keep creating money, financing the Treasury, and there will be no inflation (or any other deleterious effects that I can think of).
Once you do enough, not only does the government have to start doing real borrowing to finance its deficit; it also has to pay real interest on the outstanding debt. The government is like a monopolist facing a kinked demand curve. As long as you stay below the kink, the more you produce, the better. But as soon as you get to the kink, all Hell breaks loose. Not only are you unable to sell your marginal “new” products for a profitable price; the price of your inframarginal “old” products starts to go down too.
This puts us in a position rather like Goethe’s Faust. (I’ve only read selected passages, and those in very loose translation, so I’m relying on someone else’s analysis here, and probably an inaccurate memory even of that.) Faust is granted unlimited knowledge, until the point where he can say it is finally enough, that he has reached the culmination of human experience. At that point his soul belongs to the Devil. Similarly we are granted unlimited economic stimulus, until the point where we can say it is finally enough. At that point we are damned to Eternal Debt.
But as I argued in an earlier post
, even with a debt-financed stimulus, we have a net free lunch, in the same sense that Ricardians argue that international trade provides a net free lunch. With the stimulus, there is more produced today than there would otherwise be, and at no point in the future will production have to be reduced in order to pay for the increased production today. There is unambiguously more. There may be issues about distribution, as there are with trade, but overall there is unambiguously more. Perhaps the current generation benefits at the expense of future generations, but the current generation gains more than the future generation loses.
I want to say one other thing. Even with the biggest fiscal stimulus anyone can imagine, our debt-to-GDP ratio will still end up lower than it was at the end of World War II. As I recall, that situation didn’t work out too badly. In fact, as a representative of the Future Generations that were affected by that debt – a representative who has a self-defrosting refrigerator-freezer, an automatic washing machine and dryer, a dishwasher, an air conditioner, a flat-screen color television set, a VCR/DVD player, several personal computers, an air-conditioned car with automatic transmission and power brakes that gets 35 MPG on unleaded gasoline, a blackberry, wireless internet access, immunity to polio, the ability to make a living without putting my pants on, and the opportunity to go to sleep after dusk in New York and wake up before sunrise in London despite the time difference – I would like to thank our grandparents for choosing damnation. Hell doesn’t really seem all that bad.
And in Goethe’s version, doesn’t Faust end up going to Heaven?