Over the years, like many people, I’ve had my share of football jersey disagreements with Larry Summers, especially on the issue of financial regulation. But when it comes to fiscal policy and the impact of deficit-financed stimulus programs, I’m with him all the way, or most of it, anyways.
Writing in today’s Financial Times, Summers makes the key distinction between an economy operating at full capacity and one, such as today’s American economy, that has lots of unemployed workers and capital. At full employment, additional public spending tends to get “crowded out” by rising interest rates and falling private-sector spending. But when there is mass unemployment, an increase in government spending leads to increases in output and employment.
So far, so obvious—or so it should be to anybody who has taken Economics 101. But Summers makes a second point that sometimes gets lost in the debate. With interest rates at close to zero, banks reluctant to lend, and many nba jerseys businesses and households hoarding cash because they are too nervous to invest it, monetary policy—the other tool the government can use to stimulate the economy—loses much of its effectiveness. As Summers points out, the U.S. economy is now in, or close to being in, what Keynes referred to as a “liquidity trap,” where a Fed-inspired expansion of the money supply has little impact.
Now, liquidity traps, which economists used to consider historic relics, are not at all pleasant to experience. In many cases, they are associated with falling prices and extended periods of economic stagnation. (Ask the Japanese, who have been trapped in one for close to twenty years.) About the only good thing that can be said about liquidity traps is that they provide ideal conditions for stimulus programs. Why is this? Because in a liquidity trap, there is no such thing as “crowding out.” By definition, interest rates are stuck at zero per cent, or close to zero. Therefore, increases in soccer uniforms government spending have their full “Keynesian multiplier” effect. A dollar increase in spending, because it brings unemployed resources into use, ends up producing perhaps $1.50 or $2.00 worth of extra output and income.
Why, then, doesn’t everybody favor another stimulus program? In my opinion, most of the opposition is politically motivated. (In conservative circles, more government spending is innately bad.) But one or two economists and academics have tried to erect an intellectual case against deficit spending. If you want to read more, look at this article from Niall Ferguson, the Harvard historian, which is also on the FT Web site. When it comes down to it, however, the best Ferguson can do is to cite vague “confidence” effects. According to this worldview, what is holding back private consumption and business investment is not a lack of demand, but concern about the deficit. Of soccer jerseys course, this is precisely the argument that some opponents of F.D.R. made during the Great Depression. In this area, as in many others, it seems, we are still stuck in the thirties.
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