Commute-Time Musings on Fiscal Policy in a Depressed and Overleveraged Economy...
Nearly every economist of note and reputation that I know believes that an increase in U.S. government purchases right now would be highly likely to significantly boost employment and spending while having little or no effect on interest rates.
Nearly every economist of note and reputation that I know also believes that an increase in Greek or Portuguese government purchases right now would almost surely have little or no if not a negative effect on employment and spending and would significantly raise interest rates.
What model of the economy are we working in? What macroeconomic framework is consistent with both of these claims?
When I give talks, I say that right now if the economy were at full employment there would be an excess demand in financial markets not so much for liquid assets or long-duration assets but for safe assets. I say that as a result people have cut back on their spending on currently-produced goods and services to try to accumulate safe assets that are not there. I say that this interruption in the normal circular flow of purchasing power has caused a fall in incomes. And I say that this fall in incomes has caused a further fall in spending, production, employment. I say that the economy will not recover until the excess at full-employment levels of production and spending of desired holdings of safe assets above supply is eliminated--either because the private sector has rebuilt its balance sheets and so improved the quality of private debt of because a credit-worthy public sector has issued more debt,
I say, further, that expansionary fiscal policy by the US government today not only puts people to work directly but also increases the supply of safe assets held by businesses and households and so increases their willingness to spend out of current incomes on currently produced goods and services.
By contrast, I say, were the Greek or the Portuguese government to sell more bonds today it would degrade the quality of the safe bonds already out there in the market and not add to but subtract from the private sector's holdings of safe assets. Thus it would not believe but rather increase the excess demand for safe assets at full employment that is at the root of the problem.
Clearly underlying our thought--or at least my thought--is a somewhat more sophisticated model of government debt and the economy then old-fashioned Hicksian in IS-LM.
But what is this framework? And why haven't I seen it written out anywhere?
