Ken Rogoff says the debt crisis he has been warning about for many years is still a risk:
From Financial Crisis to Debt Crisis?, by Kenneth Rogoff, Commentary, Project Syndicate: ...How can policymakers be so certain that financial catastrophe won't soon recur when they seemed to have no idea that such a crisis would happen in the first place?
The answer is not very reassuring. Essentially, there is still a risk that the financial crisis is simply hibernating as it slowly morphs into a government debt crisis.
For better or for worse, the reason most investors are now much more confident than they were a few months ago is that governments around the world have cast a vast safety net under much of the financial system. At the same time, they have propped up economies by running massive deficits, while central banks have cut interest rates nearly to zero.
But can blanket government largesse be the final answer? Government backstops work because taxpayers have deep pockets, but no pocket is bottomless.
And when governments, particularly large ones, get into trouble, there is no backstop. With government debt levels around the world reaching heights usually seen only after wars, it is obvious that the current strategy is not sustainable. ...
We are constantly reassured that governments will not default on their debts. In fact, governments all over the world default with startling regularity, either outright or through inflation. Even the U.S., for example, significantly inflated down its debt in the 1970s, and debased the gold value of the dollar from $20 per ounce to $34 in the 1930s. ...
The ... rate at which government debt is piling up could easily lead to a second wave of financial crises within a few years. Most worrisome is America's huge dependence on foreign borrowing, particularly from China... The question today is not why no one is warning about the next crisis. They are. The question is whether political leaders are listening. ...
How Paul Krugman might respond:
So is there anything to worry about? Yes, but the dangers are political, not economic. ... Over the really long term,... the U.S. government will have big problems unless it makes some major changes. In particular, it has to rein in the growth of Medicare and Medicaid spending.
That shouldn’t be hard in the context of overall health care reform. After all, America spends far more on health care than other advanced countries, without better results, so we should be able to make our system more cost-efficient.
But that won’t happen, of course, if even the most modest attempts to improve the system are successfully demagogued — by conservatives! — as efforts to “pull the plug on grandma.”
So don’t fret about this year’s deficit; we actually need to run up federal debt right now and need to keep doing it until the economy is on a solid path to recovery. And the extra debt should be manageable. If we face a potential problem, it’s not because the economy can’t handle the extra debt. Instead, it’s the politics, stupid.
Note also that the bond price data do not show any signs of worry over inflation, default, or crowding out.
One more note. This is Rogoff in June 2008. He argues that there should be no stimulus, the risk posed by deficits is too large, and that interest rates should be raised to prevent inflation:
[P]olicymakers must refrain from excessively expansionary macroeconomic policy ... and accept the slowdown... For most central banks, this means significantly raising interest rates to combat inflation. For Treasuries, this means maintaining fiscal discipline rather than giving in to the temptation of tax rebates and fuel subsidies. In policymaker’s zealous attempts to avoid a plain vanilla supply shock recession, they are taking excessive risks with inflation and budget discipline that may ultimately lead to a much greater and more protracted downturn.
My own view is that "significantly increasing interest rates" in June 2008 would have been a disaster, and that deficit spending was needed to prevent conditions from deteriorating even further. Opposition to deficit spending from people like Rogoff only served to delay putting this policy in place. (Also: This was prior to Lehman, inflation was being driven by commodity price increases, i.e. by relative price changes which do not pose long-run inflation risks, and had the Fed followed this advice and raised rates, it would have likely reversed course after Lehman further undermining its credibility at a time when credibility was needed the most.)
[I may do more with this later, but since Rogoff's opening line is about economists missing the crisis, note also Paul Krugman's How Did Economists Get it So Wrong? Update: See also Where Does Macroeconomics Go From Here? and Which Economists Got it So Wrong?, both by Brad DeLong.]