Monday, August 08, 2011

Liberals’ Strange Retreat on Government Spending


Amplify’d from
In the 1930s, as the world plunged into depression, there were two political factions that insisted nothing could be done: Marxists, who saw the depression as the death knell of capitalism, and laissez-faire economists, who believed that the only way to revive the economy was to let the depression takes its course like a bad storm at sea. Imagine my surprise in the wake of Thursday’s stock market crash to find a similar attitude toward the current downturn among liberals and mainstream economic thinkers. 
In a column in The Washington Post, Ezra Klein said the “right question” to ask about the economy was, “Where will the recovery come from?” He responded that “no one has an answer,” but also asserted that the recovery “won’t come from the United States.” Financial Times columnist Gillian Tett said pretty much the same thing on PBS’s News Hour. “They’re out of ammo,” Tett said of the federal government. “I mean, they have already used all the fiscal measures they could in the last two or three years. And they’re pretty much back to where they can go, as far as they can go in terms of the monetary policy measures.”
I got news for Klein and Tett (which sounds like a law firm). If a real recovery occurs in the next four or five years, it will come about the same way a recovery took place after the 1930s: from a huge infusion of government spending. It won’t, one hopes, require the justification of war, but it will have to consist in the fiscal equivalent of war. If we don’t do that, we may not escape this slump for the rest of the decade—and neither will Great Britain and other countries that have also convinced themselves that reducing government is the best course of action. 
There are three kinds of measures that are needed to “solve” this kind of recession: first, short-term measures that revive consumer and investment demand; second, measures that will stimulate new domestic outlets for private investment; and third, steps that prevent the demand government creates from being siphoned off primarily in imports. For the first purpose, the best kind of measures are those that create jobs for the unemployed—whether in the public or the private sector—and that eliminate or reduce debt directly, for instance in housing or school loans. Tax cuts are not as effective because, given the level of private debt, consumers are likely to save rather than spend them. With interest rates already near zero, Federal Reserve monetary measures are also not very effective.
There is a copious amount of historical evidence that cutting spending—and cutting government jobs—is more likely to deepen a downturn. Start with the United States, Germany, and Great Britain in the first years of the Great Depression; the United States in 1937; and Japan in 1997. In each of these cases, cutting spending made things worse. To be sure, large deficits can harm an economy; but not when capacity is idle, unemployment is high, interest rates are not rising, inflation is non-existent, and a government’s currency and Treasury bills are still widely in demand.