DeLong Diagnoses the Need for More Stimulus

Brad DeLong presents the viewpoint of sensible economists who understand the horrors of a depressed economy. DeLong and others point to the nearly 30 years of depressed economic activity in Japan. This is something to be avoided. Unfortunately politicians and ideological economists are ranting about deficits and worry about inflation and are concerned that the US debt burden is too great.

Here are some key bits from the posting:

As the disappointing May job numbers confirm, this is still an exceptional time—a time in which many of the normal rules of the Dismal Science are changed and transformed. It is a time for not normal economics but rather “depression economics.” The terms on which the U.S. government can borrow now are exceptionally advantageous. And because of high unemployment the benefits of boosting government purchases and cutting taxes right now are exceptionally large.

The result is that the costs of borrow-and-spend policies are overturned for the short run—indeed, for as long as the current economic crisis of high unemployment lasts, which may well mean that the short run is not very short.

In normal times, a boost to government purchases or a cut in taxes produces a limited increase in production and employment while adding a substantial increase to the national debt. The increase in debt raises interest rates, which crowds out productivity-increasing private investment spending and, dollar for dollar, leaves us poorer after the effect of the stimulus ebbs.

The borrowing must then must be financed at a significant interest rate, and thus paid for with higher taxes, which reduce incomes by increasing the wedge between the private rewards and the social benefits of expanded production.

It's nasty business.

Normally, only government spending initiatives or tax cuts that promise a high value for the dollar are worth undertaking, but things are different now.

However, right now, as best we can tell, an increase in federal spending or a cut in taxes will produce (in the short run) no increase in interest rates and hence no crowding-out of productivity-increasing private investment. Indeed, government spending that adds to firms’ current cash flow may well boost private investment and so leave us, dollar for dollar, richer after the effect of the stimulus ebbs.

Why?

Because our debt today can be financed at extremely low interest rates—1.83 percent if financed via 30-year TIPS, and even less in expected real interest if financed over a shorter horizon.

In normal times, only government spending initiatives or tax cuts that promise a high value for the dollar are worth undertaking. Now, however, things are very different. Let’s run through the arithmetic.

...

Right now, bad politics is undermining good policy, hurting the American economy and legions of unemployed workers. It is long past time for another stimulus package.

Go read the details. The bottom line is that you can't get back what you lose during a depression. The army of unemployed during the 1930s didn't produce goods that could have been produced. You get an idea of what could have been built by looking at the WPA projects.