Paul Krugman takes on the chorus of folks who are pointing to green shoots, wringing their hands over spending and inflation, and demanding that the stimulus be rolled back.
Obama is not taking us down the road to hell, says Krugman. The economy’s still in lousy shape. Unemployment is still rising. In a liquidity trap like this, growth of the monetary base does NOT lead to inflation (see Japan). Raising the reserve requirements on banks, as inflation-howler Arthur Laffer wants to do, is exactly the mistake that killed our recovery in 1937. And so on…
Note that, regardless of who’s right here, Krugman or the US-is-Zimbabwe guys, this is why it is so unlikely that politicians and the Fed will remove the stimulus at exactly the right time. Everything’s obvious in hindsight, but only in hindsight.
At the core, it is in the interest of most decision-makers to err on the side of inflation (see Greenspan), which is why we think that, eventually, that’s where we’re headed.
The debate over economic policy has taken a predictable yet ominous turn: the crisis seems to be easing, and a chorus of critics is already demanding that the Federal Reserve and the Obama administration abandon their rescue efforts. For those who know their history, it’s déjà vu all over again — literally.
For this is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession. Yet such unconventional measures make the conventionally minded uncomfortable, and they keep pushing for a return to normalcy. In previous liquidity-trap episodes, policy makers gave in to these pressures far too soon, plunging the economy back into crisis…
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