There was one post yesterday, “Prudential Macro Policy:”
A few years ago, it was easy to say what U.S. monetary and fiscal policy should be doing. The economy was still obviously depressed, so the indicated demand policy was pedal to the metal all the way – no need to worry about inflation, no reason to believe that deficit spending would cause any crowding out (in fact it would almost surely crowd in private investment, because such investment depends on demand.)
It’s true that the right kept warning about a debased dollar, while the Very Serious People were obsessed with debt and deficits, so that in practice we didn’t do the obvious. But it was obvious.
Now, however, we’re arguably not too far from full employment. No inflation problem is visible yet, but it’s not crazy to suggest that inflation might go above the Fed’s target in the not-too-distant future. So has the macro case for strongly stimulative policy gone away?
We’ve had an extensive discussion of this question when it comes to monetary policy, in which uncertainty plays the central role. Maybe we’re at or close to full employment, and will continue in that direction; but maybe not, either because there’s more slack than we think or because adverse shocks will send the economy down again. This means that there’s a risk of getting it wrong in either direction – not raising rates soon enough to head off some rise in inflation, on one side, versus raising them too soon on the other.
And the decisive argument, it seems to me and others – although not, alas, to the Fed – is that these risks are asymmetric. Waiting too long risks embarrassment and some cost of wringing out the extra inflation, but moving too soon risks long-term stagnation. Wait until you see the whites of inflation’s eyes! (I coined that phrase, by the way.)
But what about fiscal policy? I found myself trying to clarify my thoughts here in aid of tomorrow’s column. And while I’m sure I’m not the first to say this, a similar argument applies. Think in particular about infrastructure investment, which takes a long time to get going.
Suppose we were to launch a program of deficit-financed public investment now, which would play out over the next few years. The truth is that we don’t know what the macro environment would be when the spending took place. We might be more or less at full employment, which means that the spending would cause higher interest rates and crowd out some private investment. But we also might be in a depressed state, either because of a slump in some part of domestic demand or because we’re importing secular stagnation from abroad, in which case fiscal stimulus would be just what the doctor ordered.
The point is that these are, again, asymmetric risks. A little crowding out wouldn’t kill us, given how badly we need infrastructure investment. On the other hand, if we do slide back into a liquidity trap we would be badly hurt by not having the public investment we could have had, helping to prop up demand as well as serving other purposes.
Or to put it another way, given where we are in the macro situation public investment, in addition to its usual benefits, would provide valuable insurance against the all too possible return of the zero lower bound. It’s not quite as slam-dunk a case as it was in, say, 2013, but it’s still very strong. It’s still time to borrow and spend.