Over the past two years, Nobel Prize-winning economist and New York Times columnist Paul Krugman has been one of the most vocal and noticeable advocates of economic stimulus as a means of combating the Great Recession. He is by no means alone. Other Keynesians, too, have been unhappy about the $800 billion fiscal stimulus package passed by the Obama Administration in early 2009. While conservatives have been fretting about the massive U.S. budget deficit, Prof. Krugman declared that at least twice that amount would be needed to restore the economy to health.
Prof. Krugman’s calculations are fairly mainstream and are based on accepted economic wisdom — such as Okun’s Law, first promulgated by Yale economist Arthur Okun back in 1962. Okun’s Law claims that high unemployment creates an output gap, which means that the economy functions below its potential. Every percentage point above the natural rate of unemployment creates two percentage points of output gap. If natural unemployment in the United States is 4.5 percent — and it is probably even lower — than with the jobless rate at 9.5 percent or so currently, the output gap measures around 10 percent of GDP, or $1.5 trillion. Hence, to close this output gap and to bring the U.S. economy back to its productive potential, the government will need to nearly double the Obama fiscal stimulus package.
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More recently, Krugman also criticized the U.S. Federal Reserve for policy paralysis. The Fed suspended its aggressive quantitative easing in March, stopping its purchases of mortgage-backed securities. That was a good thing, according to Krugman, because it relieved financial institutions of non-performing assets and infused liquidity that could be used for lending. More recently, faced with a slowing pace of business recovery, the Fed announced that it would reinvest the proceeds from its maturing securities into long-dated U.S. Treasuries. This represented a compromise between those who feared that all that money being tossed out of helicopters represented an inflationary threat and those who claimed that in an environment of slow growth, sluggish demand and moribund bank lending deflation, not inflation, has emerged as the biggest threat.
Even with the existing ‘modest’ fiscal package, the U.S. budget deficit is likely to measure around $1.4 trillion in the current fiscal year, matching last year’s record budget gap. It seems that continued monetary ease is a necessary condition for the U.S. government to finance its deficit spending even at its current levels, much less another fiscal package of nearly equal size.
U.S. debt by various estimates measures between $10 trillion and $14 trillion. It is likely to surpass 100 percent of GDP in nearby years, based even on the Obama Administration’s (probably optimistic) forecasts. Krugman is quick to point out, however, that by the time World War II ended the Federal government had run up an even larger debt relative to the size of the economy. Yet, the U.S. economy easily grew out of its debt burden in the next decade. Krugman and other Keynesians are convinced that deficit spending doesn’t matter as long as the money is used to bring back employment and therefore create the underpinnings for future economic growth.
On the other hand, the fact that the government has failed to fully close the output gap with a bout of public spending means that growth will remain sluggish for years.
Conservatives have attacked this reasoning because it proposes to vastly expand the role of government in the economy and cavalierly disregards the massive debt burden such policies generate. But there is another problem with this view: It assumes that economic growth is a normal condition of human society. In fact, both Keynesians and their conservative opponents share in the belief that economies are by definition supposed to grow and that if they don’t it is the fault of the government that somehow adopted a set of “wrong” or “misguided” policies.
This is certainly not supported by historical evidence. On the contrary, the opposite seems to be the case throughout human history.
We have become so used to growth — and the rapid change, progress and capitalism’s “creative destruction” which accompany it — that we simply cannot envision a world without growth. But growth is rather an aberration in the history of civilization. Some 6,000 years of recorded history show that stagnation, tradition and drift have been far more typical of human societies. In fact, over the 2,000 years of the Common Era, Western civilization grew rapidly for three or four centuries under the Roman Empire and then again over the past 250 years, since the advent of the industrial revolution and the Age of Enlightenment. True, economic growth was especially rapid since the late 19th century, but that doesn’t negate the fact that throughout the Middle Ages and the early modern period, growth was almost completely absent or extremely slow. Generation after generation of our ancestors experienced no discernible change in their economic condition or way of life.