Lost Decade, Here We Come - Paul Krugman Blog

The deficit hawks have taken over the G20:

“Those countries with serious fiscal challenges need to accelerate the pace of consolidation,” it added. “We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions”.

These words were in marked contrast to the G20’s previous communiqué from late April, which called for fiscal support to “be maintained until the recovery is firmly driven by the private sector and becomes more entrenched”.

It’s basically incredible that this is happening with unemployment in the euro area still rising, and only slight labor market progress in the US.

But don’t we need to worry about government debt? Yes — but slashing spending while the economy is still deeply depressed is both an extremely costly and quite ineffective way to reduce future debt. Costly, because it depresses the economy further; ineffective, because by depressing the economy, fiscal contraction now reduces tax receipts. A rough estimate right now is that cutting spending by 1 percent of GDP raises the unemployment rate by .75 percent compared with what it would otherwise be, yet reduces future debt by less than 0.5 percent of GDP.

The right thing, overwhelmingly, is to do things that will reduce spending and/or raise revenue after the economy has recovered — specifically, wait until after the economy is strong enough that monetary policy can offset the contractionary effects of fiscal austerity. But no: the deficit hawks want their cuts while unemployment rates are still at near-record highs and monetary policy is still hard up against the zero bound.

But what about Greece and all that? Look, right now sovereign debt problems are taking place in countries with a very specific problem: they’re part of the euro zone, AND they’re badly overvalued thanks to huge capital inflows in the good years; as a result they’re facing years of grinding deflation. Counties not in that situation are not facing any pressure from the markets for immediate cuts; as of this morning, 10-year bonds were yielding 3.51 in Britain, 3.21 in the US, 1.27 in Japan.

Yet the conventional wisdom now is that these countries must nonetheless cut — not because the markets are currently demanding it, not because it will make any noticeable difference to their long-run fiscal prospects, but because we think that the markets might demand it (even though they shouldn’t) sometime in the future.

Utter folly posing as wisdom. Incredible.

via krugman.blogs.nytimes.com

Posted via web from Brian's posterous