Friday, September 3, 2010

The Recession and Keynesianism Once Again

Christina Romer's farewell to the National Press Club as she leaves her post as chair of the Council of Economic Advisors caught my eye because I think it might have supported some statements I made in yesterday's post. The title is, "Not My Father's Recession" and refers to the recession in the early 80s that I referred to yesterday. She correctly noted that the sources of the two recessions differed and that led to differences in the depth of the recessions and caused economists to misinterpret events in late '08 and early '09. However, I am disappointed in that she didn't take the next step. She still argues for a Keynesian diagnosis and solution. She offers some reasons why the stimulus seems to have been less effective than desired, but doesn't consider other options than increased government spending. Romer writes in Keynesian terms, "The only surefire ways for policymakers to substantially increase aggregate demand in the short run are for the government to spend more and tax less. In my view, we should be moving forward on both fronts."

Paul Krugman's most recent op-ed piece in the New York Times calls on President Obama to push for a very large stimulus package. He argued in early '09 that the stimulus plan was too small and should have been much larger. He claims that the evidence is that the stimulus worked but was too small and another round is needed.

It seems to me that the stimulus plans are similar to another program used last year--the "Cash for Clunkers" program. The program stimulated auto sales while it lasted, but then there was a big drop in car sales after the program ended. The program merely shifted the timing of auto purchases and didn't impact overall demand for cars. Similarly, increased government spending increases GDP by definition, but may not jump start the rest of the economy if there are structural problems that need to be corrected, such as too much debt on the balance sheets of households. As Krugman notes in his piece, as the stimulus plan has wound down, the impact on GDP has fallen. He says this shows we need another round of stimulus. I ask, "When will the need cease?" I think the answer is when households have repaired their balance sheets. To me, this suggests the emphasis should be on reducing the tax burden on households rather than increase government spending. The increased cash flow may not generate increased spending immediately as people pay down debt, but will get us to a point when people can feel more comfortable spending again.

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