Paul Krugman identifies the single biggest, most consequential economic policy mistake of 2009

Every time I consider re-posting one of Paul Krugman's columns lately, I confront a dilemma that makes me hesitate. Almost all of them have been on-target, illuminating, and indispensable ... so if I start highlighting some of them, pretty soon I'll be doing it all the time, and things will get out of hand. The New York Times is not exactly an obscure newspaper, so readers can just follow his columns there.

But yesterday's column does seem especially worth highlighting, because it manages to boil down more than a year and a half of debates into a clear, compact, forceful statement that is clearly right (in my opinion) about a question of great importance. Here's the bottom line:

When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high — but for very different reasons.

One group — the group that got almost all the attention — declared that the stimulus was much too large, and would lead to disaster. [....] The other group, which included yours truly, warned that the plan was much too small given the economic forecasts then available. [....]

The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round. [....]

We won't get it, of course. That looks politically impossible now. And it may be that, back in 2009, passing a stimulus bill that was big enough to adequately address the economic crisis would have been politically impossible, too. So perhaps this major blunder could not, realistically, have been avoided. That's a matter for argument.

But what does seem pretty clear is that the economic "stimulus" that actually got passed—technically, the American Recovery and Reinvestment Act—wasn't big enough. Contrary to propaganda from the Republicans and other right-wing sources, which unfortunately has been swallowed by too many voters, the ARRA definitely did a lot of good, preventing the economy from getting significantly worse and perhaps even going over the edge into a full-scale depression. Unemployment rates are still terribly high, but without the ARRA they would certainly have been even higher. But the scale of the ARRA was not big enough to fully do the job.

And the ones who will suffer politically in November will be Obama and the Democrats—whereas the Republicans, who fought tooth and nail to prevent constructive measures from getting passed at all, and to sabotage and whittle down any that did get passed, will almost certainly benefit politically from the consequences. Well, no one said life was fair.

Read the whole piece (below). More on these issues soon ...

--Jeff Weintraub

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New York Times
September 2, 2010
The Real Story
By Paul Krugman

Next week, President Obama is scheduled to propose new measures to boost the economy. I hope they’re bold and substantive, since the Republicans will oppose him regardless — if he came out for motherhood, the G.O.P. would declare motherhood un-American. So he should put them on the spot for standing in the way of real action.

But let’s put politics aside and talk about what we’ve actually learned about economic policy over the past 20 months.

When Mr. Obama first proposed $800 billion in fiscal stimulus, there were two groups of critics. Both argued that unemployment would stay high — but for very different reasons.

One group — the group that got almost all the attention — declared that the stimulus was much too large, and would lead to disaster. If you were, say, reading The Wall Street Journal’s opinion pages in early 2009, you would have been repeatedly informed that the Obama plan would lead to skyrocketing interest rates and soaring inflation.

The other group, which included yours truly, warned that the plan was much too small given the economic forecasts then available. As I pointed out in February 2009, the Congressional Budget Office was predicting a $2.9 trillion hole in the economy over the next two years; an $800 billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task of filling that hole.

Critics in the second camp were particularly worried about what would happen this year, since the stimulus would have its maximum effect on growth in late 2009 then gradually fade out. Last year, many of us were already warning that the economy might stall in the second half of 2010.

So what actually happened? The administration’s optimistic forecast was wrong, but which group of pessimists was right about the reasons for that error?

Start with interest rates. Those who said the stimulus was too big predicted sharply rising rates. When rates rose in early 2009, The Wall Street Journal published an editorial titled “The Bond Vigilantes: The disciplinarians of U.S. policy makers return.” The editorial declared that it was all about fear of deficits, and concluded, “When in doubt, bet on the markets.”

But those who said the stimulus was too small argued that temporary deficits weren’t a problem as long as the economy remained depressed; we were awash in savings with nowhere to go. Interest rates, we said, would fluctuate with optimism or pessimism about future growth, not with government borrowing.

When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent when The Journal published that editorial; it’s under 2.7 percent now.

What about inflation? Amid the inflation hysteria of early 2009, the inadequate-stimulus critics pointed out that inflation always falls during sustained periods of high unemployment, and that this time should be no different. Sure enough, key measures of inflation have fallen from more than 2 percent before the economic crisis to 1 percent or less now, and Japanese-style deflation is looking like a real possibility.

Meanwhile, the timing of recent economic growth strongly supports the notion that stimulus does, indeed, boost the economy: growth accelerated last year, as the stimulus reached its predicted peak impact, but has fallen off — just as some of us feared — as the stimulus has faded.

Oh, and don’t tell me that Germany proves that austerity, not stimulus, is the way to go. Germany actually did quite a lot of stimulus — the austerity is all in the future. Also, it never had a housing bubble that burst. And with all that, German G.D.P. is still further below its precrisis peak than American G.D.P. True, Germany has done better in terms of employment — but that’s because strong unions and government policy have prevented American-style mass layoffs. [JW: On these US-German comparisons, see also here & here & and here.]

The actual lessons of 2009-2010, then, are that scare stories about stimulus are wrong, and that stimulus works when it is applied. But it wasn’t applied on a sufficient scale. And we need another round.

I know that getting that round is unlikely: Republicans and conservative Democrats won’t stand for it. And if, as expected, the G.O.P. wins big in November, this will be widely regarded as a vindication of the anti-stimulus position. Mr. Obama, we’ll be told, moved too far to the left, and his Keynesian economic doctrine was proved wrong.

But politics determines who has the power, not who has the truth. The economic theory behind the Obama stimulus has passed the test of recent events with flying colors; unfortunately, Mr. Obama, for whatever reason — yes, I’m aware that there were political constraints — initially offered a plan that was much too cautious given the scale of the economy’s problems.

So, as I said, here’s hoping that Mr. Obama goes big next week. If he does, he’ll have the facts on his side.