Big Swinging Stimulus

Willem Buiter starts the year off with a bang:

Can the US economy afford a Keynesian stimulus?

Economic policy is based on a collection of half-truths.  The nature of these half-truths changes occasionally.  Economics as a scholarly discipline consists in the periodic rediscovery and refinement of old half-truths.  Little progress has been made in the past century or so towards understanding how economic policy, rules, legislation and regulation influence economic fluctuations, financial stability, growth, poverty or inequality.  We know that a few extreme approaches that have been tried yield lousy results – central planning, self-regulating financial markets – but we don’t know much that is constructive beyond that.

The main uses of economics as a scholarly discipline are therefore negative or destructive – pointing out that certain things don’t make sense and won’t deliver the promised results.  This blog post falls into that category.

The article is (unfortunately) long, but it is impossible to overstate how much I think you should read the whole thing.

Oh, all right; if you insist on knowing just the bottom line:

There will, before long (my best guess is between two and five years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury bills and bonds are still viewed as a safe haven by many.  But learning takes place.  The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of “dark matter” or “American alpha” is not credible.

So two things will have to happen, on average and for the indefinite future, going forward. First, there will have to be some combination of higher taxes as a share of GDP or lower non-interest public spending as a share of GDP.  Second, there will have to be a large increase in national saving relative to domestic capital formation.

Note that this is exactly the opposite of what mainstream economists — both on the Left and the Right — are proposing for the near-term stimulus.  The Left wants massive spending; the Right wants massive tax cuts; by all accounts, they are all going to get exactly what they are asking for.  Buiter is worried that this will ultimately sacrifice the credit of the U.S. itself.

Do not underestimate how dangerous this is.  As long as our government can borrow at low rates of interest, our situation can only get so bad.  (Nobody is going to starve, for instance.)  Take that away, and we are performing without a net.  Are we really going to risk that just to preserve our lifestyle of McMansions, SUVs, and ever increasing consumption?  Apparently, we are.

The change, if it happens, could come very suddenly.  If you are not keeping an eye on Treasury yields, it is time to start.

This little Molotov cocktail from Prof. Buiter did not go completely unnoticed.  Krugman responds under the headline “Faith-Based Economics”.

Arnold Kling (of the Cato Institute — god bless the libertarians) uses it as an opening to register his own opposition to the Big Stimulus:

7. There is a risk that government will absorb a permanently higher share of GDP. Policymakers will be reluctant to cut public spending for fear of causing a downturn. Moreover, it will be difficult politically to cut public sending.

I suspect that for some of the proponents of fiscal stimulus, the last point is a feature, not a bug. What they really are proposing is a permanent, Galbraithian shift from the private sector to government, in the guise of a large fiscal stimulus.

Oh dear, I believe he may be talking about Prof. Krugman.