It’s a wonder we can sleep at night. No, I’m not talking about the heat wave cooking the northeast this week but rather the debate over whether the country needs—or can even afford—a second shot of federal stimulus spending. New York Time’s columnist and Nobel laureate Paul Krugman has been making the case in print and on television that the feds had better get off the stick and get more money moving before the economic recovery melts away. This contrasts with the Euro talk of fiscal restraint and a chorus of Republicans who are pointing toward that ever growing mountain of debt as we pile on deficits.
Adding to the debate is a meaty report from Goldman Sachs chief economist Jan Hatzius entitled ‘No Rush For the Exit’ in which he argues that aggressive U.S. monetary and fiscal policy—the federal stimulus— is now giving way to the deflationary drag of a depressed labor market. Like other economists, he’s also worried about the inventory cycle, which provided a nice boost to growth in recent months but has now pretty much run its course. Bottom line: More help is needed.
What’s interesting about the Hatzius report is not just the notion that we need more stimulus—the evidence is pretty solid that this economic recovery is now running largely on federal steam, and that’s beginning to peter out— but also his thought that the two most recognized risks to a second stimulus, another inflation-related asset bubble and, second, a dangerous level of debt, are not so large as to justify inaction.
To summarize his analysis, the risk of another asset bubble is certainly possible but unlikely given broad risk aversion and the fact that market valuations remain reasonable. On the debt question, Hatzius argues, “it is difficult to argue that the U.S. government has reached the limits of debt capacity when long-term bond yields are low and falling, and when federal interest payments stand at just 1.5% of GDP.”
The Goldman economist’s view on the goverment’s next best step is, first, do no harm. That is, do not follow the advice of those who advocate fiscal and monetary tightening. As for proactive moves, Hatzius proposes some long shots like a new TALF-esque special purpose vehicle that could provide cash to non banks in the form of equity and debt. Such a move would require participation from both the Treasury and the Federal Reserve, something that Hatzius concedes is a “very high hurdle.” He doesn’t advocate renewed purchased of mortgage back securities (MBS) because he’s not optimistic it could happen and he’s also not convinced that such purchases would do much to improve the MBS market since interest rate spreads are already pretty thin.
What Hatzius does argue for is an extension of unemployment benefits, continued aid to state and local governments and more time for those Bush era tax cuts, which are pegged to expire at the end of 2010. To balance such largess with credible fiscal restraint, Hatzius advocates a concomitant commitment to long-term deficit reduction. That would involve new actions to further slow the growth of entitlement spending, and possibly higher taxes down the road. This may strike many as politically impossible, but it also smacks of reasonableness. In fact, it’s the kind of common sense thinking that politicians on both sides of the aisle need to take to heart if they are going to lead us out of this troubled period.