No Convincing Economic Arguments Against Further Stimulus Spending

In much of the world, including the United States and Europe, a
debate is taking place about whether the government's first
responsibility should be to reduce unemployment - which is at elevated
levels - or to reduce government deficits and debt. Many of the
arguments for deficit reduction are simplistic, based on ignorance or
derived from ideology.

For example, there are inappropriate
comparisons of government to household debt, a fixation on absolute
numbers without any comparison to national income, or just rightwing
opposition to government in general. Although these are the most
commonly propagated views through the media, it is worth taking a moment
to examine the (ostensibly) more sophisticated and economics-based
arguments to see whether they hold water.

Kenneth Rogoff is
professor of economics at Harvard University and a former chief
economist at the International Monetary Fund (IMF). This week, he responded to some of the pro-stimulus arguments:

"Some
portray Japan, with nearly a 200% government debt to income ratio, as a
poster child for extremely indebted countries with low interest rates.
Japan's 'success', of course, has a lot to do with its government's
ability to sell debt domestically. How the country will handle its
finances as saving by retirees shrinks, and as its labour force rapidly
shrinks, remains to be seen."

Some background: Japan has a
gross debt-to-GDP ratio of about 227% of GDP. This is more than three
times the level of the United States. But more than 100 percentage
points (of GDP) of this debt is owed to the Japanese central bank. This
means that the interest payments on this debt go to the government of
Japan, so there is no interest burden added by this part of the debt. In
fact, Japan's net interest payments are less than 2% of GDP, which is a
modest amount.

It also means something else that most of the
economists in this debate are not eager to talk about: that Japan has
financed nearly half of its public debt by creating money. In other
words, instead of the government borrowing money from investors, the
central bank created money and lent it to the government. In the popular
imagination, this creation of trillions of dollars (in yen) to finance
government deficits has to cause serious inflation. However, the
Japanese experience has been the opposite: over the last 20 years,
Japan's consumer price index has risen about 5% - that's the 20-year
total, not annual inflation.

Rogoff is correct to say that the
domestic ownership of Japan's debt is key to its success. But this is
just an additional argument for the United States, or Europe, to finance
deficit spending through money creation at this time. Such financing
is, by definition, domestic ownership - ie, ownership by the central
bank. In the eurozone, the ECB would have to agree to refund
the interest payments on the debt to the borrowing countries, so as to
duplicate what Japan (and the United States) has done with its own
central bank.

Of course, Japan's debt that is held by the public
is also held mostly by domestic investors. So this part of Rogoff's
argument is really making the case for avoiding the chronic trade
deficits that the United States has run for decades. It is the
overvalued dollar, and the resulting trade deficits, that drive foreign
borrowing in the United States.

As for the warnings about what
might happen when savings and the labour force shrink, we have heard
this rhetoric for decades from deficit hawks in the United States and
Europe. Suffice it to say that there are many options open to rich
countries should they ever face the problem of a "labour shortage". But
unfortunately, our problem for the foreseeable future is the opposite.
It is a shortage of jobs, not labour.

Rogoff cites his own work,
with Carmen Reinhart, in arguing that debt-to-GDP ratios of more than
100% are "above the threshold where growth might be affected". But their
paper really doesn't show much at all, especially for economies like
the United States and the eurozone that can borrow in their own
currencies. Countries that end up with debt greater than 100% of GDP are
likely to have other problems that got them there. As others have also noted,
without controlling for these other factors - which this paper
decidedly does not do - there is no way of establishing causality. In
fact, the authors do not even control for changes in population growth,
since they look only at GDP growth, rather than per capita GDP.

Rogoff adds another self-defeating argument:

"Importantly,
governments that emphasize long-term fiscal sustainability are likely
to have an easier time inducing their central banks to maintain highly
supportive monetary conditions."

In other words, central
banks might react to expansionary fiscal policy in the present situation
by tightening monetary policy. But this just means that the central
bank should be subordinated to national economic policy, instead of the
other way around. He is taking for granted that central banks must be
"independent". But as experience has demonstrated - as when, for
example, the US Federal Reserve somehow missed the two biggest asset
bubbles in world history - this doesn't necessarily mean independent of
Wall Street; it means independent of the public interest.
So yes, a government that wants to use expansionary fiscal policy will
need the cooperation of its central bank. And should have it.

Rogoff
argues that "anemic growth with sustained high unemployment is par for
the course in post-financial-crisis recoveries." Par for whose course?
If past governments made stupid mistakes and/or didn't care about
condemning a generation of low-income young people to years of
unemployment, does that mean we should do the same?

At the end of
the day, Rogoff provides no convincing economic argument why either the
United States or Europe cannot, or should not, finance the necessary
stimulus until unemployment approaches more normal levels.