Tuesday, June 1, 2010

Are We Greece or Japan?

“Despite a chorus of voices claiming otherwise,” Paul Krugman recently wrote, “we aren’t Greece. We are, however, looking more and more like Japan.”

That’s not a bad way of describing the stakes in the sweeping argument macro-economists are having about whether we need to double down on the fiscal stimulus to get the economy moving again. On the one hand, you have neo-Keynesians like Krugman who think that, unless we do, we’re headed into the kind of deflationary spiral that Japan has been unable to escape for nearly twenty years. On the other, you have a chorus of fiscal conservatives warning that more fiscal stimulus will be self-defeating because it will crowd out the private investment that sustains a genuine economic recovery while it takes us another step down the road to insolvency.  At this rate, they argue, we'll soon have as much trouble financing our deficit as Greece is having today--but without our having anyone else to bail us out.

I can’t really say that I have the foggiest notion about which, if either, side is right. Not being an economist doesn’t keep me from understanding the plausibility of the story that each side is telling. But that doesn’t mean I can begin to tell you whether one or the other side is supplying a more serviceable model of the unfathomably complex economic realities. That’s the kind of complicated empirical question that learned economists can never seem to resolve even among themselves; they’re still arguing, after all, about the comparative effects of monetary and fiscal policy in causing and ending the Great Depression of the 1930s.

So where does that leave us citizens who believe, along with William Galston, that the “economy is too important to leave to the economists”? His answer seems to be that we find a way to split the difference: “For what it’s worth, my preferred policy,” he writes, “would link continued stimulus for another year or two (including basic safety net programs such as extended unemployment insurance) with credible commitments to shift our long-term fiscal course.”

That’s a sensible-sounding answer because it stakes out some psychologically comforting middle ground, and proposes what sounds like a reasonable political compromise. Yet it doesn’t really speak to the policy issues before us. If “stimulus for another year or two” crowds out the private investment that sustains a genuine economic recovery it’s self-defeating even in the short run and exacerbates our long-term deficit problem by exciting inflationary expectations that will be reflected in future interest rates. Yet if, as Krugman fears, deflationary expectations are taking hold throughout the economy, signaling in advance that the stimulus is just a short-term expedient is not a promising way of inducing skittish investors to make long-term bets on the future.   The conservatives and the neo-Keynesians can't both be right about our economic predicament.

And how, in any event, can any democratic government make “credible commitments to shift our long-term fiscal course”? No sitting congress or administration can bind future congresses and administrations, and we all know that politicians aren’t very good at living up to the commitments that they have the authority to undertake. If we get farther done the road to insolvency, why should the bond markets take our “long-term commitments” any more seriously than they’re taking the present representations of the Greek government?

This is a case where policy coherence and psychic comfort don’t go together. If macro-economists on either side of the debate are right, the psychologically soothing technique of splitting the difference is a recipe for policy failure. Given the extent of our capacity for rational public decision-making and the limits of our economic knowledge, we better hope that they’re both wrong.

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