Public Spending

In his Friday column, Nobel laureate Paul Krugman makes the case that assisting the financial sector will not be enough to deal with what could be a lengthy recession.  “It’s now clear that rescuing the banks is just the beginning: the nonfinancial economy is also in desperate need of help,” says Krugman.

So what should the government do to help the economy?  In terms of monetary policy, the Fed will almost certainly cut interest rates.  However, Krugman says we should not expect the rate cuts to get much traction:

There’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

Since further interest rate cuts will only have a modest impact at best, the government will need to use fiscal policy to spur the economy.  What that amounts to is some combination of public spending and tax cuts.

Not surprisingly, Krugman’s prescription calls for increased public spending, such as:

  • Extended unemployment benefits
  • emergency aid to state and local governments
  • purchasing (“but not at face value, as John McCain has proposed”) and restructuring mortgages
  • infrastructure spending

So why does Krugman call for public spending rather than tax cuts for fiscal stimulus?  First, Krugman knows that taxes are already at historically very low levels — the lowest in over 50 years.  Second, Krugman is a progressive; he does not give much weight to ‘trickle down’ theories.  Instead, Krugman wants to make sure that any government assistance first goes to those who are hit hardest.  The increase in consumer spending generated by Krugman’s proposals will in turn help the overall economy.

The good news is that next year there should be a Democrat in the White House, as well as an increased Democratic majority in Congress.  Hopefully, Democratic leaders will take bold action by implementing a plan like Krugman has proposed.