Everybody else seemed to hear Bernanke say he was in favor of fiscal stimulus as one approach to our economic problems. But I instead heard him articulate very intelligently the potential pitfalls of the strategy.
Menzie laid out very nicely on Monday the traditional concerns many economists have about trying to use new fiscal legislation to combat an economic downturn. In brief, once you take into account how much time it will take to get new proposals signed into law, and the time it will require after that before the legislation actually has its effect on the economy, you are looking at a delay of at least a year and perhaps considerably longer. If, as some fear, we are already in a recession, and if this recession lasts about 9 months (which is the average duration of the last 4 U.S. recessions), that means the recession would be over by the time the new fiscal stimulus starts to have its initial effect.
Paul Krugman argues today that although the 2001 recession technically ended November 2001, sluggish growth in employment continued for some time, so fiscal stimulus might still be welcome one or two years from now. But it was just such thinking that led the Federal Reserve to keep the fed funds rate at 1% through 2004, a policy that I think most of us recognize today to have been a serious mistake. Overstimulus at the wrong time lays the seeds for resurgence of inflation. And the process of trying to bring that inflation back down later could be the cause of the next recession after this one is long over.
If we take as a particular example the case of tax cuts, this is something many politicians were advocating before the latest indications that a downturn may have begun, and something many of them would still be advocating even if a recession was long past. Whatever the nature of the stimulus package Congress may approve and the President sign, I cannot imagine that there would fail to be a strong constituency seeking to ensure that it is anything but a temporary change. Thus when I read Bernanke’s warnings–
To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next twelve months or so. Stimulus that comes too late will not help support economic activity in the near term, and it could be actively destabilizing if it comes at a time when growth is already improving. Thus, fiscal measures that involve long lead times or result in additional economic activity only over a protracted period, whatever their intrinsic merits might be, will not provide stimulus when it is most needed. Any fiscal package should also be efficient, in the sense of maximizing the amount of near-term stimulus per dollar of increased federal expenditure or lost revenue. Finally, any program should be explicitly temporary…
–I thought to myself, of course Bernanke’s exactly right, and of course this is exactly what Congress and the President are inherently incapable of doing.
I have another concern as well, and this arises from the observation that previous fiscal deficits have greatly tied our hands in the current situation. I worry (perhaps excessively) that the U.S. may be in danger of surrendering our status as the preferred safe haven for international capital, and can envision a situation in which there is a rapid flight from U.S. assets that could cause some very difficult dislocations. That’s the kind of thing that really should never happen to the United States. Due to our sheer size and long traditions, the U.S. is uniquely positioned to reap enormous benefits from an unquestioned commitment to price stability and honoring existing financial commitments. In my opinion, the reckless U.S. budget deficits of recent years have been one of the most important threats to that special and very valuable status. And again I heard that theme raised by Bernanke today, albeit with milder language than I might have used:
the nation faces daunting long-run budget challenges associated with an aging population, rising health-care costs, and other factors. A fiscal program that increased the structural budget deficit would only make confronting those challenges more difficult.
So I guess if you thought, of course Congress and the President are up to the task of meeting these long-run fiscal challenges responsibly, and of course they’ll make sure the changes adopted now are timely and strictly temporary, then I suppose you’d read Bernanke as giving the green light for fiscal stimulus. But the light I see him shining seems to have a pretty hefty dose of red in it.