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Et Tu, Doug?: Fiscal Policy Edition

Doug Elmendorf writes:

Director's Blog » Blog Archive » Federal Budget Math: We Can’t Repeat the Past: Despite the low projected figure for defense spending and all other spending, the high costs of the major health care programs and Social Security mean that total outlays apart from interest on the debt are projected to be 20.5 percent of GDP in 2021, nearly 2 percentage points above the 40-year average. After interest payments are included, total outlays are projected to be nearly 24 percent of GDP, 6 percentage points more than the average amount of revenues during the past 40 years.

Therefore, given the aging of the population and the rising cost of health care, the United States cannot achieve all of the following objectives in the future:

  • Keep federal revenues at their average share of GDP during the past 40 years.
  • Provide the same sorts of benefits for older Americans that we have provided in the past 40 years.
  • Operate the rest of the federal government in line with its role in our economy and society during the past 40 years.

Putting fiscal policy on a sustainable path will require significant changes relative to our historical experience in popular programs, people’s tax payments, or both.

What this misses is that these are problems for the post-2015 period--not for right now. And we do not have the post-2015 congress here now to solve these problems. We should attempt to bind the post-2015 congress through supermajority provisions and triggers so that if we have post-2015 gridlock we won't go careening off into disaster. But that is all we can do right now.

What Doug Elmendorf's piece fails to mention is that right now we have an immediate problem that is as great a threat to American economic welfare as our post-2015 structural deficit. Right now we have nine percent unemployment, a static employment-to-population ratio, the threat of a double dip if not deflation, and an obstructionist Republican Party that, as Clive Crook wrote, "deserves political annihilation."

Right now cutting spending or raising taxes would be counterproductive--it would certainly push GDP down and unemployment up, and in my view at least stands a better than even chance of making our long-run deficit outlook worse.

Hoisted from the Archives:

Debt Arithmetic and Expansionary Policy: Paul Krugman Vastly Understates His Case - Grasping Reality with Both Hands: [T]he Keynesian logic for expansion right now is reinforced by the fact that recessions and austerity programs cast shadows: raise unemployment now via austerity cuts in government spending, and some of that increased unemployment sticks around permanently as higher structural unemployment. Call the share of unemployment that does so s. Then an austerity program today worsens the long-run debt-and-deficit picture if:

mt > (r - g)/(r - g + s)

if m is the multiplier, t is the marginal tax rate, s is the share of the recession rise in unemployment that turns into a permanent rise in unemployment, r is the real interest rate on government debt, and g is the economy's real growth rate. Since right now mt is about 0.5, and r is less than 2% per year, this means that further fiscal expansion is good for the long-run debt-and-deficit right now as long as:

s + g > 2%

As long as the sum of the economy's long-term growth rate--which is now about 3%--and the share of a rise in unemployment that becomes structural is greater than 2%--which it definitely is--fiscal expansion is a good thing.

Second, even if you have no Keynesian effects in the model at all, there is still an overwhelming case for borrow-and-spend right now. Why? Because the thirty-year Treasury inflation-indexed security rate at 1.86% per year is lower than the expected long-run growth rate of the real economy right now of close to 3% per year.

This is a basic topic sometimes taught in intermediate undergraduate macroeconomics: the neoclassical optimizing growth "Golden Rule."

If the economy ever gets itself into a situation in which risk-adjusted long-run interest rates are lower than the risk-adjusted expected long-run growth rate of the economy, it is dynamically inefficient--and government should borrow and spend and keep borrowing and spending until at least it drives long-term interest rates up to and above the risk-adjusted expected long-run growth rate. (And the Keynesian multiplier and the shadows cast by recessions strengthen the case for spending.)

Yet I find none of the classical, semi-classical, new classical, or neoclassical economists who believe in optimizing growth models stepping forward and saying: "Because r < g right now, what we really need is more government spending and an expanded government debt."

It is very odd...