Photo: Daniel Lobo via Flickr
In a note put out in September, Nomura economist Richard Koo argued against the popular idea that the US economy needs is short-term stimulus and long-term fiscal reform.As he put it, such talk was as “indecent” as a surgeon badgering a patient about their insurance as they were heading into an emergency.
Last night we caught up with Koo by phone and talked more about fiscal issues and the super-committee, and he expounded more on the folly of addressing long-term fiscal issues.
Here’s the exchange:
Are you worried about the next step of the supercommittee and what that could mean in terms of imminent fiscal entrenchment?
Well, all of that effort in my view is headed in the wrong direction because U.S. private sector is still deleveraging at these very low interest rates, which suggests that they are not comfortable with their balance sheets. And in circumstances like that, government should be increasing its fiscal stimulus, not decreasing it.
Now, long-term entitlements, I think they can discuss that. And if they find a good formula to reduce problems with this long-term entitlement, they should be encouraged to do so. But even on that point, you have this term called “policy duration effect.” People see that, “Yeah, fiscal stimulus is coming, but it’s only for two years and after that they’re gonna cut budget deficit,” then even those two years with fiscal stimulus might not have the maximum impact when people think that after two years everything will be back to this mess. And if you don’t think your balance sheet is repaired within two years, then you start preparing for the worst today.
And so, the part of the problem with long-term fiscal consolidation against short-term fiscal stimulus… it sounds like the responsible thing to do at one level, but it’s not responsible when you look at the maximum impact of fiscal stimulus that you do have in place at the moment because the policy duration effect will be operating in reverse.
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