Barclays Debate with Robert Barro, Moderated by David Wessel
WESSEL: If President Obama invited you into the Oval Office, told you that he recognized that the economic policies he has pursued to date haven't had the desired outcome, and gave you five minutes to tell him what in your opinion he should do now (setting aside whether Congress would go along)?
DELONG: I would say: Mr. President: When you took office, you quickly became convinced for some reason that we were going to see a rapid, "V"-shaped recovery. Hence you took your task to be (a) stopping the panic, (b) recapitalizing the banking system, and (c) filling in a good chunk of the demand gap with the Recovery Act. Then, you thought, the task of macroeconomic stabilization would be finished. And so you turned your attention to (i) health care reform, (ii) financial regulation, (iii) long-run budget balance, and other issues.
This was wrong. We do not have a "V" but rather an "L". Our expectations that the market was strong enough to return the economy to its long-run full-employment configuration within a couple of years--perhaps with assistance from the Federal Reserve--was wrong. The short run of slack aggregate demand, high unemployment, and low capacity utilization looks as though it will last not two to three years after the downturn begin but five to ten years--or more.
What to do? If Milton Friedman were here to advise you, he would give the same advice he gave Japan in the 1990s: Have the Federal Reserve buy bonds for cash. Have it keep buying bonds for cash until total nominal spending in the economy is on a satisfactory trajectory. Announce that it is going to keep buying bonds for cash until total nominal spending is on a satisfactory trajectory.
Milton Friedman's teacher, the ur-monetarist Jacob Viner, had a somewhat different take. Viner worried that when--as now--interest rates are very low, people have no incentive to spend their cash. And when you take bonds out of circulation you reduce the supply and further lower interest rates further. Viner sought a way to boost the money stock without pushing interest rates down further. He recommended coordinated monetary and fiscal expansion: the Federal Reserve buys bonds for cash, and the Treasury than issues bonds and spends, in order to (a) expond the money supply, (b) directly put people to work and © keep falling interest rates from further depressing monetary velocity and so crowding out the beneficial effects of monetary expansion.
Both Friedman and Viner would, right now, say that the problem is that their policy recommendations have not been tried on a large enough scale commensurate with the seriousness of the problem.
And when will it be time to think about long-term budget balance? As I believe my colleague Christina Romer used to tell you every single week: the bond market and the inflation rate will tell you when it is time to turn to dealing with long-term budget balance. They are certainly not telling you to do so now.