Today's Biggest Economic Fights: Stimulus, Austerity, and the Fed

How can the public sort out such differences among economists?


Chad Stone is chief economist at the Center on Budget and Policy Priorities.

Here are three big questions about current economic policy: Was the 2009 Economic Recovery Act good for the economy and could we use more such stimulus? Is cutting the budget deficit as quickly as possible (austerity, Europe style) the best policy for promoting a stronger economic recovery? Should the Federal Reserve focus more on stimulating economic growth and job creation and less on inflation right now?

I have my answers: yes, no, and yes. But others reach opposite conclusions.

How can the public sort out such differences among economists? When I throw epithets at the TV during typically unenlightening economic discussions on the Sunday talk shows, the noneconomist in my household asks, "Why don't they have someone on who can tell us who's telling the truth and who isn't?"

My first response is a variant of an age-old question: who will fact-check the fact-checker? But, disputes among economists go well beyond differences over facts. Economic policy is about trade offs and, while economists are trained to identify trade offs, they don't have any special claim to making better choices among competing objectives than policymakers armed with the same information about the trade offs. We're human, and our values influence our policy recommendations.

[See a collection of political cartoons on the economy.]

So here's a brief guide to interpreting different views on the three questions above.

Does deficit-financed fiscal stimulus work?

Almost all economists agree that if the government runs a larger budget deficit in order to increase food stamps and unemployment insurance and invest more in infrastructure, people on food stamps and unemployment insurance would have more money to spend and we'd add to our infrastructure. But would we produce more goods and services in total and would we create more jobs?

I would say it depends. If we did this in 1999 when the economy was expanding and the unemployment rate was falling toward 4 percent, I would say no because I would expect the Fed, fearing that the extra stimulus would generate inflationary pressures, would react by putting on the monetary policy brakes. The resulting interest rate hikes would discourage interest-sensitive spending on housing and business investment and drive up the value of the dollar, reducing net exports. If the Fed did not react in time, we would likely see inflation start to rise.

[Read the U.S. News debate: Has the Federal Reserve Overstepped its Mandate?]

Like the Congressional Budget Office, the Federal Reserve, and many mainstream economists, I see the economy of the past four years as quite different, with considerable economic slack and room to expand without generating inflationary pressure or higher interest rates due to temporary budget deficits. I'd ask those who believe otherwise to point to the evidence of inflationary pressure or interest rate pressure that would signify problems with further fiscal stimulus. Here's where my values come in: I believe that any inflationary or debt costs from pursuing a more expansionary short-run fiscal policy are far outweighed by the economic and social costs of continuing to tolerate too-high unemployment

When to cut the budget deficit

My organization, the Center on Budget and Policy Priorities, has long argued that we face a bleak fiscal future if we don't address structural imbalances in the budget related to Bush-era tax cuts, the graying of the population, and rising healthcare costs throughout the U.S. healthcare system. In our analysis, the financial crisis and recession and the temporary policies undertaken to keep the economy from an even more severe downturn produced temporary increases in the deficit but are not a major factor in the longer term.

[See a collection of political cartoons on the budget and deficit.]

That's at odds with the view that we face a looming debt crisis rather than a longer-term problem, but I don't think it's at odds with the facts. In my first post for this blog, I cited Congressional Budget Office Director Doug Elmendorf's statement that there is no inherent contradiction between accepting larger budget deficits in the short run to give a boost to a weak economy and achieving longer-term fiscal sustainability by enacting policies to reduce the deficit in the future when the economy is stronger.

Others believe that we are in imminent danger of higher interest rates and that austerity is the best way to promote economic growth. The evidence we have doesn't support the view that interest rates will rise sharply anytime soon, but we can't dismiss the possibility entirely. And Europe's experiment with austerity is not working, but it's not over. Once again, my value system and reading of the evidence tell me that betting on austerity is a loser.

Monetary policy

To end on bright note, both Dean Baker and Paul Krugman give kudos to the Washington Post's Robert Samuelson for the way he discusses the trade offs that the Fed faces in fighting inflation versus promoting stronger economic growth—even though they strongly disagree with his conclusions.

Once again, it's about trade offs. Yes, we face some risk of more inflation from trying to promote stronger economic growth and job creation with a more expansionary monetary policy. But, as the indispensable economics blogger Mark Thoma puts it, inflation can help stimulate a depressed economy. And in my value system, that's a good thing.

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