Do-Nothing Bias at the Fed?
Quote of the Day: May 8, 2012

Long-Term Policy Initatives Need Not Crowd-Out Short-Term Expansion: Ezra Klein Stages a Debate Between Larry Summers and Raghu Rajan

Ezra Klein:

Larry Summers vs. the long-termers: [Today Rajan] is once again on the opposite side of the issue from Summers. This time, however, there has been an unusual role reversal: It is Summers who is trying to rouse an economics profession that has settled into a kind of complacency, and Rajan whose argument is more comfortable to much of the political and economic establishment.

Rajan’s commentary is perhaps the clearest manifesto yet from the school of post-recession thought that I’ve come to think of as “the long-termers.” The long-termers don’t deny the enormous and ongoing human suffering caused by the recession… [but] they argue that there’s not much that we can or should do in the short run…. But as Summers sees it, the short run has a nasty tendency to become the long run:

The evidence is that cyclical problems harden into structural problems, because people who have been out of work for a year lose their ability to work.

The longer you’ve been unemployed, the harder it is to get back into the labor force. [Michael Reich:]

If you’ve been unemployed for a few weeks, your chance of finding a job is 30 or 40 percent. If you’ve been unemployed for six months, it’s 10 percent….

Summers, alongside Berkeley’s Brad DeLong, showed that in a depressed economy, stimulus measures could pay for themselves if they worked to prevent these kinds of long-term labor crises.

Rajan… thinks that as long as the housing market is choking on foreclosures, there’s not much that monetary policy can do, as it mainly works through stimulating demand for housing:

I don’t see great short-term solutions. When people say austerity is not the answer, fine; if you have great things to spend on, let us know what they are.

To Summers, though, this fatalism is sober-sounding nonsense:

Surely we can have public employment grow as rapidly as it did during George W. Bush or Bill Clinton’s presidency,. Surely we can have classes across America be as small as they were five years ago. Surely if you put more money into the hands of lower-income people they will spend a substantial fraction of it.

In a reversal from their earlier debates, it is now Rajan’s argument that is easier for the political class to embrace: Proposing more stimulus, or more expansionary Federal Reserve policy, is politically dangerous in a way that calling for education reform simply isn’t.

But unlike before, we don’t have to choose between the two sides. We could spend more on teachers and classroom repairs now while passing budget cuts and tax increases that really kick in after unemployment has dropped to, say, 7 percent. We could rebuild the nation’s infrastructure while doubling down on our education reforms. We could, in other words, make both the short term and long term better. But we’re doing neither…