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Wednesday, July 29, 2015

'Second-best Macroeconomics'

Paul Krugman wonders if he has been advocating for the right type of policies:

Second-best Macroeconomics: The ... economic problems facing both the United States and Europe have been quite straightforward and comprehensible. ... So no worries: just hit the big macroeconomic That Was Easy button, and soon the troubles will be over.
Except that all the natural answers to our problems have been ruled out politically. Austerians not only block the use of fiscal policy, they drive it in the wrong direction; a rise in the inflation target is impossible given both central-banker prejudices and the power of the goldbug right. Exchange rate adjustment is blocked by the disappearance of European national currencies, plus extreme fear over technical difficulties in reintroducing them.
As a result, we’re stuck with highly problematic second-best policies like quantitative easing and internal devaluation. ... In case you don’t know, “second best” ... comes from a classic 1956 paper by Lipsey and Lancaster, which showed that policies which might seem to distort markets may nonetheless help the economy if markets are already distorted by other factors. ...
The problems with second best as a policy rationale are familiar. For one thing, it’s always better to address existing distortions directly, if you can — second best policies generally have undesirable side effects... There’s also a political economy concern,... in a complicated world you can come up with a second best rationale for practically anything. ...
But here we are, with anything resembling first-best macroeconomic policy ruled out by political prejudice, and the distortions we’re trying to correct are huge — one global depression can ruin your whole day. So we have quantitative easing, which is of uncertain effectiveness, probably distorts financial markets at least a bit, and gets trashed all the time by people stressing its real or presumed faults; someone like me is then put in the position of having to defend a policy I would never have chosen if there seemed to be a viable alternative. ...
Which makes me ask myself the question: Do people like me spend too much time being limited by what is presumed to be politically practical? Should we devote more time to trying to widen the range of options, to pointing out that we really would be much better off if we threw off the fetters of conventional deficit fears, the 2 percent inflation target, and the extremely ill-advised euro project?

    Posted by on Wednesday, July 29, 2015 at 12:24 AM in Economics, Policy, Politics | Permalink  Comments (202)


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