DeLong: A Time to Spend

Brad DeLong argues that "the first principle of macroeconomic policy is that because only the government can create the investment-grade financial assets that are in short supply in a depression, it is the government’s task to do so." He then asks, "How well have the world’s governments performed this task over the past three years?":

A Time to Spend, by J. Bradford DeLong, Commentary, Project Syndicate: The central insight of macroeconomics is a fact that was known to John Stuart Mill in the first third of the nineteenth century: there can be a large gap between supply and demand for pretty much all currently produced goods and services and types of labor if there is an equally large excess demand for financial assets. And this fundamental fact is a source of big trouble.

A normal gap between supply and demand for some subset of currently produced commodities is not a serious problem, because it is balanced by excess demand for other currently produced commodities. ... The economy rapidly rebalances itself... By contrast, a gap between supply and demand when the corresponding excess demand is for financial assets is a recipe for economic meltdown. ... Thus, because only the government can create the investment-grade financial assets that are in short supply in a depression, it is the government’s task to do so. ...

How well have the world’s governments performed this task over the past three years?  In East Asia (minus Japan), governments appear to have been doing rather well. ... In North America, governments appear to have muddled through. They have not provided enough bank guarantees, forced enough mortgage renegotiations, increased spending enough ... to ... and facilitate a rapid return to full employment. But unemployment has not climbed far above 10%, either.

The most serious problems right now are in Europe. Uncertainty about how, exactly, the liabilities of highly leveraged banks and over-leveraged peripheral governments are to be guaranteed is shrinking the supply of safe savings vehicles at a time when macroeconomic rebalancing calls for it to be rising. And the rapid reductions in budget deficits that European governments are now pledged to undertake can only increase the likelihood of a full double-dip recession.

The broad pattern is clear: the more that governments have worried about enabling future moral hazard by excessive bailouts and sought to stem the rise in public debt, the worse their countries’ economies have performed. The more that they have focused on policies to put people back to work in the short run, the better their economies have done. ...