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Why We Need To Spend Big

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Christina Romer explains exactly why at the Brookings Institute today.

Some key points:

This similarity of causes between the Depression and today’s recession means that President Obama begins his presidency and his drive for recovery with many of the same challenges that Franklin Roosevelt faced in 1933. Our consumers and businesses are in no mood to spend or invest; our financial institutions are severely strained and hesitant to lend; short-term interest rates are effectively zero, leaving little room for conventional monetary policy; and world demand provides little hope for lifting the economy. Yet, the United States did recover from the Great Depression. What lessons can modern policymakers learn from that episode that could help them make the recovery faster and stronger today?

One crucial lesson from the 1930s is that a small fiscal expansion has only small effects. […]

The key fact is that while Roosevelt’s fiscal actions were a bold break from the past, they were nevertheless small relative to the size of the problem. When Roosevelt took office in 1933, real GDP was more than 30% below its normal trend level. (For comparison, the U.S. economy is currently estimated to be between 5 and 10% below trend.)9 The emergency spending that Roosevelt did was precedent-breaking—balanced budgets had certainly been the norm up to that point. But, it was quite small. […]

Because of balanced budget requirements, state and local governments are forced to cut spending and raise tax rates when economic activity declines and state tax revenues fall. At the same time that Roosevelt was running unprecedented federal deficits, state and local governments were switching to running surpluses to get their fiscal houses in order.11 The result was that the total fiscal expansion in the 1930s was very small indeed. As a result, it could only have a modest direct impact on the state of the economy.

And so the plans for massive spending are put in place.

I know many of you think that spending this money will result in our complete collapse, but I’d like to point out one very important distinction and that is this: everybody’s going down the tubes. In a situation like this, aggressive fiscal expansion makes sense because every single economic power are taking very similar measures too. So the risk of inflation or our currency falling out of favor is virtually nonexistent right now. The same logic obviously wouldn’t apply during a time when the rest of the world wasn’t facing a collective economic crisis, but that’s not where we’re at and the distinction is important.

Also, given the reality that where we’re seriously lagging behind up and coming super powers like China in new infrastructure spending, now is the perfect opportunity to quickly play catch up. Because, trust me, they’re starting to pull away. They’re building entire cities that will leave no carbon foot prints and produce all their own energy. Where’s that innovation stateside? Only a massive tornado could convince us to try such things, and certainly not on the ambitious scale that China is undertaking.

In any event, read the rest of Romer’s piece. I believe in the administration’s approach because it makes sense to me given this unique time in our worldwide financial history.

I welcome your thoughts…