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Fiscal Stimulus
Posted by: Jon Henke on Friday, January 18, 2008

Fiscal stimulus while we're at full employment?

Paul Krugman, December 2000
Cheney's remarks were those of a vulgar Keynesian — a believer in the now- discredited doctrine that taxes and spending should be routinely twiddled in an attempt to "fine-tune" the economy. Decades of experience shows that this is a bad idea, that when governments try to fight garden-variety recessions by cutting taxes or increasing spending they almost always get it wrong. By the time Congress has finished negotiating who gets what, and puts the new law into effect, the recession is usually past — and the fiscal stimulus arrives just when it is least needed.

Fiscal pump-priming has its place; it's appropriate in the face of deep and persistent slumps. But otherwise we should make budgets for the long run, and let the Fed deal with short-run problems by adjusting interest rates. It's disturbing that Mr. Cheney seems unaware of this basic policy rule.
Paul Krugman, August 2001
Can we pump up the economy with additional tax cuts or temporary public spending? Not safely; those huge future tax cuts have created a grim long-term financial outlook, and any further tax cuts would make the outlook even grimmer.
Paul Krugman, September 2001
What about fiscal policy? Some liberals have recently made common cause with the Bush administration, arguing that the economic slump is a reason to put aside promises to protect the Social Security surplus. But those liberals are making a big mistake.

Even on the straight economics of the case, it is by no means clear what good it would do to give up on protecting Social Security. By and large, the spending decisions that Congress will make over the next few months won't have much impact on the economy until late next year at the earliest. Even pessimistic analysts think that a recovery will already be under way by then.

Furthermore, responsible behavior can be rewarded — and irresponsible behavior punished — quite quickly. In 1993, in the face of a still-sluggish economy, Robert Rubin and Larry Summers urged Bill Clinton to commit himself to fiscal discipline. Such a commitment, they argued, would help keep long-term interest rates down and would do more to stimulate the economy, even in the short run, than any attempt to pump it up with deficit spending. And they were vindicated by events.
Paul Krugman, September 2001
The conventional wisdom among economic analysts is that fiscal policy is not necessary to deal with most recessions, that interest-rate policy is enough. In other words, they believe that stabilizing the economy is properly the job of the Fed, not the Treasury Department. But the possibility of fiscal action always stands in reserve.
Paul Krugman, October 2001
Basically, monetarists wanted to get the government out of the business of short-term economic management. First and foremost this meant rejecting the use of fiscal policy — discretionary tax cuts or spending increases — to fight recessions.

By and large this was an argument that the monetarists won on the evidence. Few economists now accept [Milton] Friedman's further view that even monetary policy should be placed on cruise control. Alas, it turns out that a stable money supply is no guarantee of a stable economy. But almost all economists now agree with the position that monetary policy, not fiscal policy, is the tool of choice for fighting recessions.
And finally, Paul Krugman in May 2003, when the Fed Funds rate was 1.25%.
[D]o I need to point out that the case for fiscal policy to create jobs rests mainly on the fact that the economy is near a liquidity trap? If the interest rate were currently 5 percent, we'd all say that the Fed needs to cut more, while the Treasury and the Congress should focus on long-term fiscal responsibility. It's the Fed's possible ineffectuality that makes us reach for another tool.
The Federal funds rate today is 4.25% - not far at all from 5%.
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