Why the argument that we can't have short-term stimulus without long-term deficit reduction doesn't hold up.
Let's say there are two obvious things I should be doing to make my life better: being healthier now and saving more for retirement. We'll say that it is hard to disagree with these two items, and that these are obviously smart moves for me to make.
Given that they are the smart things to do, I should try to do both at the same time, right? I shouldn't let my failure to do one prevent my ability to do the other. It would be weird for me to tell my doctor I was going keep on eating multiple triple bacon cheeseburgers because I wasn't maxing out my 401(k) contributions; my accountant would be puzzled if I told him I wasn't going to invest my savings for retirement until I dropped some weight. There could be convoluted situations in which I could only do both -- no point in saving for retirement if I'm not going to make it there -- but it would have to be backed up by undeniable facts, since it would involve not trying to do something I believed was a good idea.
Yet this is how elite, center-leaning policy intellectuals think on the issue of deficits. The Very Serious People, if you will. They think we need to increase the size of the short-term deficit. They also think that we need to reduce the size of the long-term deficit. But they think that these two actions can only move together and, like I told my doctor and accountant, if one doesn't happen the other can't either. This is often known as the two-deficits problem, which I last talked about in The Nation.
Take the Domenici-Rivlin Restoring America's Future plan. In the overview it states, "First, we must recover from the deep recession that has thrown millions out of work... Second, we must take immediate steps to reduce the unsustainable debt ... These two challenges must be addressed at the same time, not sequentially." (The deficit hawk Comeback America Initiative report is similiar, with $500 billion dollars in infrastructure over two years tied to focusing on long-term deficit reduction.)
It's never very clear why these two must move together. The more aggressive argument is that the market will panic and raise interest rates if the long-term deficit is not addressed, immediately canceling out the stimulus. The more widely used version is that stimulus now would increase the longer-term debt, hence making the longer-term challenges worse and the crises and challenges occur more quickly.
This is why something like Delong-Summers paper "Fiscal Policy in a Depressed Economy" is so important. It finds that "under what we defend as plausible assumptions of temporary expansionary fiscal policies may well reduce long-run debt-financing burdens."
As Seth Ackerman noted, there's something gleeful in seeing Delong-Summers, in their focus on hysteresis in Europe, dismiss the "principal alternative theory was that high unemployment in Europe in the 1980s and 1990s" as "principally a supply-side phenomenon...and rigid labor market institutions... See Krugman (1994)" in a footnote (!), as if that's not a major reversal or anything. But the argument that, from the debt-to-GDP point of view, fiscal stimulus in a depressed economy is a smart investment by itself, is important for countering the idea that it must be linked to something else in the long term.
Here's where Peter Orszag's "Barbell Approach Only Way to Lift Heavy Economy" enters the picture. Orszag argues that that Delong-Summers approach is flawed because it ignores this two-deficits (or what he calls the barbell) problem, which argues that even if short-term stimulus is a good idea it should be linked to long-term deficit reduction. To use the opening analogy, even if getting healthy is a good idea, we should only try it if we save more for retirement. Why is this?
But these stimulus-only proposals, by not lifting the other side of the barbell, are incomplete for three reasons: First, substantial stimulus-only proposals have no chance of being enacted. Second, even if they could be, they would accelerate the date at which we again run up against the debt limit -- and their proponents have no strategy for dealing with that impediment. Finally, even if the debt limit were simply assumed away (an ivory-tower approach that might prove appealing to some stimulus-only proponents), the impact of any stimulus would be stronger, and our international credibility enhanced, if it were combined with specific, but delayed, actions to reduce the deficit.
The first is a political problem, not an economic one. It should be noted that the barbell strategy, as enacted in 2011 by President Obama, lead to his lowest approval ratings and the sense that he was being politically destroyed by his Republican counterparts. The Republican presidential primary debates featured all candidates saying that they wouldn't accept a 10-to-1 cut-to-tax ratio; it doesn't seem like this strategy is likely to have a political edge anytime soon. Also politics is a matter of elite opinion, and elite opinion isn't an asteroid that falls out of the sky. It is a series of assertions made and defended by elites like Orszag. He can choose to try and change that, like Summers is, if he'd like. Elite opinion is often wrong, and I believe it is wrong here. But one can't create and defend it while arguing it is a constraint.
The second, referring to the debt ceiling, is also a political problem, but I'd argue that nobody seems to have a particularly good strategy for dealing with it. Even so, if the problem is Republicans refusing to vote to increase the debt ceiling in a time of crisis, that needs to be addressed as a political problem; it doesn't refute the smart economic idea of fiscal stimulus in a depressed economy. (Sometimes the limit is referred to as a debt-to-GDP limit where, once past, growth slows. See Josh Bivens tear apart those kinds of arguments here
The third is an economic argument, which says long-term deficit reduction measures would increase the credibility of the United States. Normally that translates into lower long-term interest rates for government borrowing. Would that help? Here's Peter Orszag arguing against QE2
in December 2010: "a modest reduction in long-term interest rates will not have much effect on economic activity at a time when corporations are flush with cash and worried about the future." Would a few basis points gained through credibility help now, especially if the long-term effects were painful? Even if it did, it may bolster the case for the barbell approach, but it still doesn't necessitate it.
That 2010 editorial is fascinating because it argues that we need "more fiscal expansion (read: more stimulus) now" and "much more deficit reduction, enacted now, to take effect in two to three years." It's one and a half years later, and we still need the same exact thing according, to common wisdom: more fiscal expansion now, and deficit reduction in two to three years. That a bond vigilante revolt that was scheduled starting in 2012-2013 turned into a bond vigilante rally; Treasuries are at record lows, even lower than in 2010. Which is to say that our credibility hasn't been in play -- even a ratings downgrade hasn't changed anything. Rather than being terrified of the United States' fiscal position, capital markets are desperate for the U.S. to find something productive to do and are willing to loan us the money to do it at ultra-cheap rates. It would be great for us to take advantage of this smart economic move without holding it ransom to the possibility of challenges in the distant future.
Follow or contact the Rortybomb blog: