I find myself very much in agreement with Paul Krugman‘s op-ed yesterday*. I think the case for short term stimulus, or rather short-term anti-contractionary spending, and long-term austerity is fairly solid. I do think we should be concerned about confidence, and that the small risk of sudden flight from treasuries should be a variable in our optimal policy function, but don’t think these make for a credible case against short-term stimulus.
Here is something I don’t understand about austerity now proponents: is cutting short term spending a second best alternative to fixing the long-term budget problem? Or does the optimal policy response include BOTH short-term spending cuts and a long-term budget fix? If the answer is the latter, than I want to know what problems aren’t solved by fixing the long-term budget problems that also require short term cuts?
As near as I can tell, you need to be against all stimulus all the time in order to support short term spending cuts. Russ Roberts is one of these, and Kevin Murphy made a good case some time ago as well. I think it’s an intellectually defensible position, and I understand it. But if we don’t fix the long-term problems, then as far as confidence and bond vigilantes are concerned, short term spending is completely beside the point. The damages to a worst case scenario of stimulus spending pales in comparison with the worst case scenario if we don’t fix the long-term budget, so even the biggest stimulus critic should agree that stimulus plus long-term budget fix is a second best policy to a long-term budget fix alone, and either should be preferred to doing nothing.
I think the best case against short term stimulus is to say that the government can’t be trusted to combine a serious long-term budget fix with a short term stimulus package. This means that no matter what they promise they will really pass a stimulus package without long-term cuts, which it will signal to the market that they are even more cowardly with respect to addressing the long-term problems than we first thought, and thus the fiscal position just got worse vis-a-vis politicians ability to handle it.
I think this is wrong though. If stimulus critics were to settle for a second best policy and use their political capital to haggle for serious long-term budget fix I think they could be successful. Like Krugman, Ezra Klein, and Brad Delong, most liberals already seem to agree on the need for long-term budget fix, and so conservatives should be able to get a good deal on a long-term fix that they like.
*I promise you I’m not just saying this in a weak attempt to win back some credibility in the eyes of Brad Delong