The 2009 and 2010 Deficits Are Indeed Triumphs

I’ve been saying for a while that, contrary to the GOP rhetoric that the sky is falling, the 2009 and 2010 deficits were and are the absolutely correct fiscal policies. Back in October I called the $1.4 trillion deficit “a triumph” and said it was clear that’s what needed to be done given that businesses and consumers weren’t spending and, most importantly, that monetary policy had done just about all it was going to be able to do.

Paul Krugman yesterday provided three paragraphs in an excellent longer piece that explained this further:

A while back Goldman estimated that if it weren’t for the lower bound, the current Fed funds rate would be minus 5 percent, and that to achieve the same effect as a further 5 points of Fed funds cuts the Fed would have to expand its balance sheet to $10 trillion; I wouldn’t stake my life on those estimates, but they seem in the right ballpark. Obviously, the Fed isn’t doing that.

Or put it a different way: suppose the real economic outlook were the same as it is — with all indications being that unemployment will stay very high for years to come — but that the current Fed funds rate were, say, 4 percent. Clearly the Fed would feel obliged to engage in a lot more expansion, cutting rates sharply and rapidly. But with short-term rates at zero, the Fed is instead merely on hold — it is not expanding its quantitative easing, and is in fact in the process of pulling back.

The point is that while you can think of things the Fed can do even at the zero lower bound, that lower bound is in practice a major constraint on policy. By all means let’s yell at the Fed to do more, but when you’re considering other issues — like the effects of fiscal policy or the effects of renminbi undervaluation — you have to assess them in terms of the central bank you have, not the central bank you wish you had.

I’ll say it again: Those in the Obama administration who recognized the extraordinary limits of all of the other potential tools to deal with the economic situation deserve far more credit than they are getting for the deficit they were willing to recommend in spite of what they had to know would be mega criticism from the GOP. Those who voted for the legislation that raised the deficit to the recommended levels in the face of fierce-but-undeserved criticism should be resoundingly praised and rewarded rather than castigated.

Not all budget deficits are triumphs. The deficits recorded during the early part of the George W. Bush administration, for example, which occurred when the economy was considered to be strong and stimulus wasn’t needed, were as close to political, economic, and fiscal sin as you can get.

But the 2009 and 2010 deficits should be recognized for what they are: the right policies at the right time and place.

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