https://www.nytimes.com/2020/03/07/opinion/the-case-for-permanent-stimulus-wonkish.html
If you're a normal human being considering reading this post, fair warning: although it's not super-technical, it's aimed at a very wonky audience, and parts of it won't exactly be in English. Also, it's of limited policy relevance: the Trump administration would never consider the policy I suggest, and even a Biden administration would probably balk at going where I suggest. The only reason I'm writing about it is to get the idea out there. Oh, and I don't think it's very different from what Larry Summers has been saying, but I thought it might be helpful to put some stylized numbers to what I believe, and believe he believes.
OK, if you're still with me: I hereby propose that the next U.S. president and Congress move to permanently spend an additional 2 percent of GDP on public investment, broadly defined (infrastructure, for sure, but also things like R&D and child development) — and not pay for it.
The starting point for my argument is the astonishing drop in interest rates over the past few weeks. They were historically very low even a year ago, but at the time of writing the 10-year rate was only 0.76 percent. That's below the rates on Japanese debt during the Lost Decade:
What this tells us is that the bond market isn't just pricing in a global recession driven by the coronavirus, but that it expects the Fed funds rate to be near zero a lot of the time looking forward. That is, the market sees a future of secular stagnation, in which the economy is in a liquidity trap, that is, a situation in which monetary policy loses most of its traction, much if not most of the time. We were in a liquidity trap for 8 of the past 12 years; the market now appears to believe that something like this is the new normal.
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Conventional monetary policy doesn't work in a liquidity trap, but fiscal policy is highly effective. The problem is that the kind of fiscal policy you really want — public investment that takes advantage of very low interest rates and strengthens the economy in the long run — is hard to get going on short notice. That's why current proposals for fiscal stimulus, like the one advanced by Jason Furman, basically involve handing out cash — a good idea given the constraints, but a shame given the missed opportunity to invest in the future.
Hence my suggestion. Why not put investment-centered stimulus in place all the time? It would cushion the economy when adverse shocks hit. It wouldn't be necessary to achieve full employment in better times, but it wouldn't hurt either, given low interest rates and the need for public investment.
But, you say, what about debt? Well, that's where the arithmetic of debt in an era of low interest rates becomes crucial to understand.
Let's consider a stylized, round-number economy that I'll call "America." This economy currently has public debt equal to 100 percent of GDP. It can expect, on average, to experience nominal GDP growth of 4 percent a year, half real, half inflation. It can also expect, on average, to pay an interest rate of 2 percent on its debt. The actual numbers don't match my example exactly — right now, growth prospects may be a bit worse than that, but interest rates are even lower. But I think this is close enough to make my point.
In the long run, fiscal policy is sustainable if it stabilizes the ratio of debt to GDP. Because interest rates are below the growth rate, our hypothetical economy can in fact stabilize the debt ratio while running persistent primary deficits (deficits not including interest payments.)
Let d be the ratio of debt to GDP, b be the primary balance as a share of GDP, r and g be the interest and growth rates, respectively. Then the equation for debt dynamics (I warned you, normal human beings) is
Change in d = -b + (r — g)*d
So in my hypothetical case, where d = 1 (debt is 100 percent of GDP), the debt ratio can be stabilized while running a primary deficit of 2 percent of GDP.
Put the interest payments back in, and this translates to a headline deficit of 4 percent of GDP. Our actual deficit is a bit bigger than that, but we could get back into that range by repealing Trump's giveaways to corporations, which don't seem to be doing anything for investment anyway.
OK, now let's introduce a public investment program of 2 percent of GDP, with no pay-fors. The debt ratio will now begin to rise, but not without limit. If nothing else changes, d will eventually stabilize at 2 — debt at 200 percent of GDP.
That's terrible, right? Um, why? Don't tell me about the burden of paying interest on the debt — that's already taken into account by the calculation. Maybe we'd have a debt crisis, but Japan has debt exceeding 200 percent of GDP, with no crisis in sight.
-- via my feedly newsfeed
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