There is a new paper on fiscal policy out by Larry Summers and Jason Furman (There is also a video presentation of their paper along with a star-studded discussion panel including Ben Bernanke, Olivier Blanchard and Ken Rogoff here. It begins at 49 minutes).
The paper argues that the drastic fall in real-interest rates over the last thirty years has made regular fiscal stimulus by government both necessary and sustainable.
The assumption that low interest rates are here to stay leads to three conclusions:
- Fiscal policy is needed: There have been persistent shortfalls of demand since the crisis. Monetary policy is increasingly constrained in dealing with this. Interest rates have been zero (or below) zero for years. QE and perpetually loose monetary policy also comes with financial stability risks. More tools are needed.
- Fiscal policy is affordable: With interest rates so low, debt servicing costs are low. In fact, real interest payments as a % of GDP have been falling in the US since 2000.
- Fiscal policy is effective: There are lots of threads to this, but there are two broad points. First, it builds off research arguing that the cost of debt may not be as significant as once thought in an environment of low interest rates. Second, it builds off research that shows fiscal spending might be more effective than once thought. Governments can make productive investments which pay for themselves by increasing future output by a larger amount.
This kind of argument is increasingly the norm, and it sounds so obvious that it is worth reminding ourselves of the consensus they are critiquing. From the 1980s/90s, up until even the early/mid 2010s, it was believed that the best contribution government could make to macroeconomic growth was a balanced budget. There was a role for some moderate automatic stabilisers (e.g. unemployment benefits), but not much beyond that. If any macroeconomic stimulus was required in a crisis, it should be left to monetary policy and independent central banks.
Their contribution joins the broader reform conversation going on in macroeconomics today. Earlier this year, Anna Stansbury and Larry Summers co-authored a piece blaming the economic doldrums on declining worker power. Olivier Blanchard used his 2019 address to the AEA to discuss why public debt may not be as bad as once thought. If you would like an overview of the contemporary debates in macro, I highly recommend Blanchard and Summers’s introduction to the edited book: “Evolution or Revolution? Rethinking Macroeconomic Policy after the Great Recession.”
I’m going to be following up on this paper and fiscal policy more broadly over the next week. Stay tuned!