Krugman on the Stimulus Debate

In his NY Times op-ed, Paul Krugman reviews the history of the stimulus and the debate that swirled around it. His article is the best review of the facts about this debate:

When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high — but for very different reasons.

One group — the group that got almost all the attention — declared that the stimulus was much too large, and would lead to disaster. If you were, say, reading The Wall Street Journal’s opinion pages in early 2009, you would have been repeatedly informed that the Obama plan would lead to skyrocketing interest rates and soaring inflation.

The other group, which included yours truly, warned that the plan was much too small given the economic forecasts then available. As I pointed out in February 2009, the Congressional Budget Office was predicting a $2.9 trillion hole in the economy over the next two years; an $800 billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task of filling that hole.

Critics in the second camp were particularly worried about what would happen this year, since the stimulus would have its maximum effect on growth in late 2009 then gradually fade out. Last year, many of us were already warning that the economy might stall in the second half of 2010.

So what actually happened? The administration’s optimistic forecast was wrong, but which group of pessimists was right about the reasons for that error?

Start with interest rates. Those who said the stimulus was too big predicted sharply rising rates. When rates rose in early 2009, The Wall Street Journal published an editorial titled “The Bond Vigilantes: The disciplinarians of U.S. policy makers return.” The editorial declared that it was all about fear of deficits, and concluded, “When in doubt, bet on the markets.”

But those who said the stimulus was too small argued that temporary deficits weren’t a problem as long as the economy remained depressed; we were awash in savings with nowhere to go. Interest rates, we said, would fluctuate with optimism or pessimism about future growth, not with government borrowing.

When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent when The Journal published that editorial; it’s under 2.7 percent now.

What about inflation? Amid the inflation hysteria of early 2009, the inadequate-stimulus critics pointed out that inflation always falls during sustained periods of high unemployment, and that this time should be no different. Sure enough, key measures of inflation have fallen from more than 2 percent before the economic crisis to 1 percent or less now, and Japanese-style deflation is looking like a real possibility.

Meanwhile, the timing of recent economic growth strongly supports the notion that stimulus does, indeed, boost the economy: growth accelerated last year, as the stimulus reached its predicted peak impact, but has fallen off — just as some of us feared — as the stimulus has faded.

Oh, and don’t tell me that Germany proves that austerity, not stimulus, is the way to go. Germany actually did quite a lot of stimulus — the austerity is all in the future. Also, it never had a housing bubble that burst. And with all that, German G.D.P. is still further below its precrisis peak than American G.D.P. True, Germany has done better in terms of employment — but that’s because strong unions and government policy have prevented American-style mass layoffs.

The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round.

Paul Krugman uses this article to plead for Obama to stop hestitating. He needs to come out strongly for a stimulus in order to rally partisans to counter the growing tide of Republicans who taste blood. Their obstruction of any effort to revive the economy has hamstrung Obama who seems unwilling to counter Republican lies. Obama has consistently undermined his own policies by seeking "compromise" from obstructionist Republicans who see no advantage in compromise. The more they can turn Obama's administration into a flailing, uncertain, unsuccessful presidency, the more votes they expect. Votes that will bring back the deregulation crazies who created the financial collapse. Votes that will bring more tax cuts for the rich which will widen even further the gap between the top 1% of Americans who are swallowing up 80% of the economic gains while leaving the other 99% to fight over the remaining 20%.