The Economist: Is Fiscal Expansion Self-Sustaining?
Our answer is: right now, yes it is, but not usually.
The London Economist:
A theory of fiscal policy: Self-sustaining stimulus: Larry Summers says fiscal stimulus can pay for itself: WHEN he was at the Treasury nearly 20 years ago Larry Summers would counsel President Bill Clinton on the merits of “stimulative austerity”: cut deficits, and interest rates will fall by enough to produce stronger economic growth. Now Mr Summers is making the opposite case: stimulate growth through a bigger deficit, and the long-term debt may shrink.
In a new paper written with Brad DeLong of the University of California, Berkeley, Mr Summers, now at Harvard after a stint as Barack Obama’s chief economic adviser, says that in the odd circumstances America faces today temporary stimulus “may actually be self-financing”…. Mr DeLong and Mr Summers are careful to say stimulus almost never pays for itself. When the economy is near full employment, deficits crowd out private spending and investment. In a recession the central bank will respond to fiscal stimulus by keeping interest rates higher than they would otherwise be. Both effects mean that in normal times the fiscal “multiplier”—the amount by which output rises for each dollar of government spending or tax cuts—is probably close to zero.
Such constraints are not present now…. Many economists have made this point. Mr DeLong and Mr Summers go further by introducing the role of “hysteresis”—the tendency of a temporary change in unemployment to become permanent. Mr Summers has looked into this topic before. In an early paper he found that the surge in demand for women workers during the second world war permanently raised the presence of women in the workforce, a case of positive hysteresis.
The worry now is very different. Between 3% and 4% of the labour force has been unemployed for at least six months (see chart), the highest proportion in over 60 years. The longer the economy stays depressed, the more likely those workers are to quit the labour force altogether. By putting these people back to work today, stimulus generates higher taxes not just this year but for years to come, lowering the long-term debt burden….
Their conclusions apply “only in circumstances of a kind we haven’t seen in the US in 70-some years, and once this episode ends, won’t see again in more than 70 years,” says Mr Summers. Even now, “it depends on the ability to do something that may be politically hard: keeping the stimulus timely and targeted.”
