Poor Richard Koo talks sense. But his adversary in the pages of the Economist is… Allan Meltzer.
When the U.S. government can borrow at a real interest rate of -0.65%/year for five years, the case for larger deficits now--for pulling spending forward from the future into the present and pushing taxes back from the present into the future--is unanswerable: of course the government should borrow more on such terms: households value the taxes they will pay in the future if taxes are pushed back as much less painful than the taxes they would otherwise pay today, and a huge number of government spending programs offer at least a zero percent real rate of return via their effect on the productive capacity of the economy. Even if expansionary fiscal policy had no effect on capacity utilization and unemployment bigger deficits now while the government can borrow on such terms would be a no-brainer. And since expansionary fiscal policy does have such effects, it is something that you should advocate even if you have less than no brain at all--even if you have a negative brain.
But Allan Meltzer finds a way to oppose pulling spending forward into the present and pushing taxes back in the future. However, the way he finds is by not dealing with any of the arguments for expansionary fiscal policy at all:
Allan Meltzer: The Obama stimulus is an example of bad advice leading to bad policy. Much of the pressure for additional stimulus now comes from those who want to repeat their error…. [T]emporary tax cuts have been tried repeatedly. Stacks of research support the theory. It is not enough to point to the number of unemployed and part-time employed to claim that something must be done. Mistaken actions do much more harm than good in part because they destroy confidence.
The analysis on which pressure for more spending rests is incomplete and flawed. There are two major omissions in the argument. Temporary spending to shore up or expand the welfare state directs resources mainly to saving not consumption. A well-designed policy that increases productivity is the key to creating good jobs at good wages. Also, increased spending financed by selling debt offsets much of any temporary stimulus. The public understands that higher debt today requires higher taxes tomorrow. Proponents of short-term spending ignore the financing; the public does not.
The simple models used to demonstrate the effectiveness of more government spending invoke a spending multiplier to show that those receiving an increase in demand for their product spend part of the proceeds, thereby generating additional demand, and invoking still further rounds of spending. After more than 50 years of estimating the size of the multiplier, the answer is that no one can be certain of its size. Estimates range from negative (yes negative) values to two, three or higher. A negative value means that spending is crowded out; a value of two or higher means that each dollar of government spending adds two or more dollars to total spending. Shouldn't the public demand that the case for more spending have a better foundation?
It takes at least 200,000 new jobs every month to lower the unemployment rate. Suppose the unlikely happens: new, temporary stimulus triples the growth rate of the first half of 2011, so it rises to 2.4% in the second half. Even that would not make a major dent in the unemployment rate. I know of no one who believes that a short-term fix will pull the American economy back to its long-term growth path. We face years of recovery. The correct response is to avoid more policy mistakes and concentrate on steps to raise investor confidence. That does not mean doing nothing. It means taking actions that remove some of the massive uncertainty that investors face. When you do not know what the tax rate will be, or what the government will do to raise energy, health care, finance and other costs, you cannot make a reasonable estimate of the uncertain return on new investment. Cash is your friend, so you hold it. And that is what investors are doing…
It is certainly not the case that Allan Meltzer is talking to me. I know that uncertainty about future tax rates was as great in 2006, when the unemployment rate was 4.5%, as it is today when unemployment is 9%. So was uncertainty about what the government was going to do to solve its long-run health-care spending problems, deal with global warming, deal with dependence on foreign energy sources, and regulate finance. Yet--as Allan Meltzer surely knows--investors weren't holding cash in 2006.
It is certainly not the case that Allan Meltzer is talking to anybody who knows about the labor market. As Allan Meltzer surely knows, the fact that a fiscal stimulus would not solve our entire excess unemployment problem has no bearing on whether such stimulus is a net benefit.
It is certainly not the case that Allan Meltzer is talking to us fellow economists. As Allan Meltzer surely knows, a higher multiplier than expected is not an argument against but rather an argument for fiscal stimulus, and claims of a negative multiplier--that measures like the surge of federal spending in World War II actually reduced measured GDP--lack all credibility.
It is certainly not the case that Allan Meltzer is talking to anybody who knows about how American government works. Aid to state and local governments does not increase saving but rather increases government consumption and investment. Debt-financed government spending crowds out private investment only when it raises interest rates--which it is definitely not doing now.
The real arguments against pulling spending forward and pushing taxes back right now are three:
- Such policies would reduce unemployment in the next eighteen months and so raise Barack Obama's reelection chances--and it is very important for the future of America that Barack Obama be defeated.
- It is much more important to keep government spending low than to reduce unemployment.
- Even though financial markets are extremely willing to hold seemingly-unlimited quantities of U.S. Treasury debt at astonishingly high prices right now, markets are on a knife-edge and the issuance of relatively small amounts of additional U.S. Treasury debt will panic the markets and cause a sovereign debt crisis in the U.S.
The problem, I think, is that those who believe in arguments (1) and (2) know that they are political losers--that most Americans do not believe that it is good to crash the American economy in order to achieve the twin goals of defeating Barack Obama and shrinking the U.S. government. And those who believe in argument (3) know that there is no empirical evidence for it right now at all.
Thus we get things like this.
Surely Greg Ip, as moderator of this debate, has a duty to point out to the Economist's readers that uncertainty was as great in 2006 as it is today, that it is better to do some good than no good at all, that uncertainty about multipliers is not a persuasive argument against fiscal stimulus, and that with interest rates at their current levels crowding out is a complete red herring?