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Tuesday, March 30, 2010

Is a Frugal Policy the Better Solution?

Jeff Sachs is more hawkish than I would have guessed:

A frugal policy is the better solution, by George Osborne and Jeffrey Sachs, Commentary, Financial Times: Virtually all policy analysts agree that the path to renewed prosperity in Europe and the US depends on a credible plan to re-establish sound public finances. Without such a plan, the travails which have hit Greece ... will soon enough threaten the UK, US, and other deficit-ridden countries. In the recent duel of macro-economists, one camp has called for early budget consolidation... We agree. Others want more fiscal stimulus, delaying deficit reduction. We believe delaying the start of deficit reduction would put long-term recovery at risk. Such an approach misjudges politics, financial markets, and underlying economic realities.
Blaming our predicament on financial markets, as some in the second camp do, ignores the awkward truth that governments have enabled, if not enthusiastically promoted, recklessness, through chronic deficits and lax financial regulation. Our predicament, in this sense, is a political crisis at least as much as a financial one. We can’t expect “credibility” by succumbing to temptation just one more time. ...
Self-described Keynesians, including Paul Krugman, and Lords Layard and Skidelsky, see the financial markets as benignly ready to finance budget deficits, pointing to low market interest rates. By contrast, we believe financial markets are perfectly capable of getting spooked about the prospects of debt financing in the medium term. ...
The general notion that delay is beneficial in the short term because it provokes more spending today – irrespective of future debt burdens – is also wrong... If the starting position is a large structural deficit, further fiscal “stimulus” can darken consumer and business confidence by creating fears about future debt burdens. These fears may be translated directly into higher borrowing costs today for government and the private economy. ...
Sustainable recovery is a medium- and long-term project: investing in the next generation of technologies, workers, and families. Those who are hurt between the collapse of the recent bubble and the start of a new growth era must of course be protected. But it is naive to believe that governments can create high-quality, high-productivity jobs that last by inflating bubbles or digging ditches.
Government and the private sector will be complementary forces in a real, sustained, job-creating recovery. The new jobs must be largely in the private sector. But the public sector has a critical role in ensuring that the conditions for sustainable growth are in place. These include the regulation of and finance for modern infrastructure, high-quality education, pre-commercial innovation, and a world-class science and technology base. ...
Our priority should be a medium-term fiscal framework, with the first steps starting this year. That must be matched by improvements in the delivery of health, education, skills, and technology; social protection for those in need; and a decent regard for the long-term investments needed to rebuild an economy crushed by the bubbles of wishful thinking.

The economy is not yet ready for an increase in taxes or a cut in spending. Cutting the deficit too soon could undermine the recovery and send the economy back into recession. We'll get there soon enough, but we're not there yet.

Their solution might be "sustainable" if we had the social programs in place to automatically protect those "who are hurt between the collapse of the recent bubble and the start of a new growth era." But we don't, and we aren't going to get them anytime soon, so the protection must come from sustained government intervention.

How long should the help be sustained? With labor markets in such poor shape, it's too soon for government stimulus programs to be scaled back. If anything, more help is needed. Once labor markets are healthy, we can and should begin to wind down the stimulus effort and begin to address long-run deficit issues, but, again, we're not there yet.

    Posted by on Tuesday, March 30, 2010 at 12:51 AM in Economics, Fiscal Policy, Social Insurance, Unemployment | Permalink  Comments (45)


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