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Tue May 15, 2012, 12:28 AM

The Case for Overreacting

The Case for Overreacting

Via Mark Thoma, Simon Wren-Lewis argues that if we’re up against the zero lower bound but are uncertain about the size of the output gap — how far the economy is operating below potential — we should deliberately overreach on fiscal policy. Why? Because monetary policy can correct any excess stimulus, but not an inadequate stimulus.

Actually, I made exactly the same argument in November 2008, part of my pleading with the incoming Obama team to go big on stimulus. Unfortunately, the memo actually sent to the president said just the opposite, arguing that it would be easier to beef up an inadequate stimulus than to pare back an overlarge one.



This is such an important point. The Fed can crash the economy any time. Any time. The 1981-1982 recession was mandated by the Fed to attack inflation. Volker just raised rates until the economy strangled. No mystery to it. The Fed has never failed to reduce economic activity when it wanted to, assuming it accepts on the human cost of doing so. But when people are already paying the human cost of a weak economy there's no sensible argument for avoiding growth because there might be a (smaller) human cost down the road!? (If that sounds familiar, it's the RW social security argument. "We must cut benefits today, or else we would have to cut benefits in 2030.)

It is so easy to stop activity because you are raising rates and there is no upward limit. Eventually people will stop borrowing. In the other hand, when rates get down to zero you cannot offer any further monetary stimulus.

So there is never a real danger of runaway growth, runaway inflation. Those are things we can control. (And have controlled the hell out of from 1982-2012 with no sign of letting up.) On the other hand, we cannot mandate growth the same way. So you punch it to get out of the ditch and then apply the brakes as needed.

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cthulu2016 May 2012 OP
pnwmom May 2012 #1
cthulu2016 May 2012 #2
bhikkhu May 2012 #3

Response to cthulu2016 (Original post)

Tue May 15, 2012, 10:19 AM

3. Good educational point about how those things work

...but congress is highly unlikely to buy into it, for the usual ideological reasons. A bigger stimulus was tried and rejected, as it would be again, so the slow and steady growth we have is probably the best we can expect.

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