This is a question to my fellow Keynesians mostly, many of whom may find the fact that I am even posing it disappointing. I have been thinking about it a lot lately.
Right now my position is still that a fiscal deal needs to be based short-run accomodation and long-run tightening: the Romer model. I would be fine with extending the Bush tax cuts (all of them) and doing more stimulus, and actually growing the federal government rather than threatening it with sequestration, in exchange for serious entitlement reform (with benefits "on the table" as they say) and a repeal of the Bush tax cuts a couple years from now. We can even probably start phasing out a lot of these tax expenditures now as a demonstrated commitment to changes later without too much ill effect. And just end this whole debt ceiling thing. Or set the debt ceiling at 100 trillion and forget about it.
But every day I wonder how long this is going to be tenable. We probably won't get a clean Romer model if something like this does happen. What we'd get is kicking the can down the road with some broad outlines for a long-term debt deal, and that will probably not be helpful.
So at what point do we throw in the towel and focus on the FOMC instead? At what point does all this budget pressure just tie our hands to do anything worthwhile with fiscal policy? Japan suggests we have a lot of running room, but maybe not.
I look at the insanity in Washington right now and am seeing that not only is it paralyzing government, it's making the quality of government worse. They are planning for bad government because they are forced to plan for across the board cuts motivated by a misguided austerity impulse. This has very real costs. Those costs can be alleviated if we stop pushing the fiscal side of things and work on the FOMC. That has limits. You can print all the cash you want but there's no guarantee that you can make people spend cash. The government can quite literally make people spend cash (they collect it in taxes or borrow it first, of course) and the government can also give the Fed traction in monetary policy by borrowing from the market (this is one of Krugman's points in the Japan paper). So I know the risks and limits, and that's why my title is put in the form of a question. I haven't thrown in the towel yet, in other words. But when should we think about this?
The thing to remember is that it's not just about interest rates in a liquidity trap. The worry is not what interest rates will do if we have a deficit that's ten percent of GDP next year. I'm not worried about that. What I'm worried about is coming out of this crisis with debt at 150% of GDP and a looming entitlements problem. What will interest rates do then? What kind of grand bargains will we have to do then to make things work.
Another way of putting this is that at some point the short-run turns into the long-run and I am increasingly wondering how close we are to that. Is it better to start dealing with the long-run problems now to avoid constraints on governance that lead to bad governance, and just let the Fed deal with the crisis?
When you compare this crisis to the depression there is some reason to be proud of what we've accomplished. When you look at it's on it's own, it's really a terrible mess.
Noted for May 25, 2013
17 minutes ago