Why have mainstream economists lost the argument about the need for more economic stimulus?

Summary: Mainstream economists have recommended additional rounds of stimulus as the economies slow in Japan, the EU, and USA. Instead the Austerians have won the political debate, recommending the liquidationist policies of Hoover in 1929-30.

Brad DeLong (Prof Economics, Berkeley) asks “How Is It That We Have Lost the Argument?” — It’s the triumph of dingbat economics.

That fiscal contraction is expansionary when it is part of a package including substantial real exchange rate depreciation and substantial interest rate reductions by the central banks … But the world’s exchange rate cannot depreciate against itself right now. North Atlantic central banks (Britain’s aside) have no room to reduce the interest rates they control. The only argument left is that fiscal contraction will shrink risk premia and boost private-sector confidence–but no fiscal contraction now will solve the long-term financing problems of the North Atlantic social insurance states. …

A Keynesian economist would say that demand is way low — and that the government needs to boost it.

A monetarist economist would say that spending is way low — and so the government can either boost velocity by boosting the opportunity cost of holding money (which is most easily done by printing more government bonds, running bigger deficits) or boost the money stock by printing money.

A market-oriented economist would say that U.S. Treasury (and German government, and Japanese government bonds) right now are extraordinarily valuable assets — and thus that the way to maximize economic value is to print more of them, i.e. run bigger government deficits.

The only response I hear is that the market lacks confidence. But the market doesn’t lack confidence in the government. The market lacks confidence in the private sector — it lacks confidence that unemployment will be low and capacity utilization high enough for private businesses to make the operating profits needed to service their debt, and that the financial system is well-enough capitalized …

I could understand losing the argument if consumer price inflation was rising, if expectations of inflation in the Treasury-TIPS spreads were rising, if real interest rates on long U.S. Treasury bonds were rising, if there were any signs at all that we were moving from the green zone to the yellow zone as far as the U.S. Treasury bond’s status as safe asset in the world economy were concerned. But we are not doing that.

He’s right. The developed nations are either doing nothing (allowing their stimulus programs to run off), or implementing austerity programs which slow their economies. Painful consequences will result.

Paul Krugman answers DeLong’s question: “Against The Super-Asinine, The Gods Themselves Contend in Vain“, blog of the New York Times, 23 June 2010.

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