Tuesday, January 27, 2009

Too slow? No problem!

Paul Krugman acknowledges that his/Obama's stimulus plan is too slow.
Every economics textbook — mine too! — warns that stimulus based on public spending has a habit of peaking much too late, and therefore ends up being counterproductive... It’s not a problem if some or even most of the stimulus arrives after the official recession, as determined by the NBER, is over.
So, how long should fiscal stimulus continue?
The reason we’re talking about fiscal policy is the fact that monetary policy is up against the zero lower bound. Stimulus will still be valuable as long as we’re still up against that bound — which is likely to be the case for a long time.
Just so we're all clear, Japan has been up against the zero bound not for about 20 years.

Increasing the Federal Deficit so that it meets the private sector's desire to net save, and thus support aggregate demand, is at the heart of any fiscal stimulus plan. Krugman, and pretty much every other economist, does not understand how the Federal deficit is required to fund the private sector's demand to keep cash in their bank account.

Krugman's argument is that, since increasing G by an inadequate amount, slowly, is going to keep unemployment high (and not meet the private sector's demand to save) it doesn't matter if G happens late. The circularity of this is obvious and ridiculous. If the Government enacted a faster, payroll tax driven stimulus, then households would have repaired their balance sheets faster, and unemployment would fall sooner.

Monetary policy has an indirect effect on the economy (as we can see now) so it's always somewhat ineffective at controlling the economy. The very ineffectualness of Krugman's stimulus is also his excuse for why it doesn't matter if it doesn't kick in until 2010/11. The fact that people are losing their jobs now seems not to register.

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