Krugman

What It Would Have Taken by Krugman 

Brad DeLong is wrong. He thinks we have a disagreement, but he’s misinterpreting what I said when I argued that the Fed’s 2008 inflation phobia wasn’t responsible for the Great Recession and the Lesser Depression that have followed and continue to this day. 

What Brad says — and I agree with — is that there is no economic necessity behind our ongoing employment and output disaster. We could and should have moved the resources employed in the housing boom to other uses, and needn’t have paid this immense cost. 

But what would it have taken — what would it take now — to have maintained or restored full employment? My argument is that it would have required more radical, aggressive policies than anyone close to the levers of power has been willing to contemplate, at any point along the way. So the fact that the Fed was wrongly obsessed with inflation for most of 2008, the original subject of my post, was just a contributing factor; things would have been a bit better, but nowhere near OK, if the Fed had stayed focused on underlying inflation and ignored the effects of the commodity-price blip. 

Think of it this way: what would a really effective set of policies be right now? First of all, we should aggressively reverse the fiscal austerity of the last few years, getting government at all levels spending several points of GDP more to boost demand. 

Monetary policy should accommodate that boost; interest rates should not go up even if inflation goes somewhat above 2 percent. In fact, there’s an overwhelming prudential case for raising the inflation target — even if we’re not sure about secula(r) stagnation, it might be true, and we definitely know that the risk of hitting the zero lower bound is much higher than Fed officials imagined when they settled on 2 percent as the magic number. 

I’m not totally wedded to these particular numbers, but let’s say for the sake of argument that the right policy is two years of fiscal expansion amounting to 3 percent of GDP each year, plus a permanent rise in the inflation target to 4 percent. These wouldn’t be radical moves in terms of Econ 101 — they are in fact pretty much what textbook models would suggest make sense given what we have learned about macroeconomic vulnerabilities. But they are completely outside the bounds of respectable discussion. 

That’s the sense in which we are “doomed” to long-term stagnation. We have met the enemy, and it’s not the economic fundamentals, it’s us.