Robert Samuelson: Economics Is Hard

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Monday, 28 June 2010 04:51

That seems to be the main point of Robert Samuelson's column today. It might be a bit easier with a bit more careful thought.

For example, Samuelson tells readers that the debt burdens of major countries are rapidly approaching "financial and psychological limits" that prevent further fiscal stimulus. He then cites the 92 percent debt to GDP ratio for France, 82 percent for Germany, and 83 percent for the UK as countries that are reaching these limits.

If he was looking for financial and psychological limits, he might have considered the case of Japan. Its debt to GDP ratio is close to 220 percent. Its interest payment take up a bit more than 1.0 percent of GDP each year and it can borrow at long-term interest rates of around 1.5 percent. This is possible because its central bank has bought up much of the government's debt over the last 15 years. Since the economy remains well below its capacity, the central bank's actions have not to led to inflation. In fact, Japan continues to be troubled by deflation.

The European Central Bank could similarly adopt a policy of buying and holding large amounts of the debt of euro member governments. The interest on debt held by the central bank does not impose a burden on governments, since it is rebated to them.

The column also touts some recent research which purports to show the benefits of deficit reduction as stimulus. It is worth noting that nearly all the examples of deficit reduction as stimulus involve countries that faced very high interest rates and in which trade comprised a very large share of the economy.

In these circumstances, a reduction in the deficit could produce a substantial stimulus through two channels. First, it would lower interest rates, which would provide a direct boost to domestic investment and consumption. Second, lower interest rates would lower the value of the currency, which in turn would make its goods more competitive internationally, thereby increasing net exports.

These conditions do not apply for most countries at present and certainly not to the United States. It is very doubtful that even the strongest deficit reduction measures will have a noticeable effect on lowering already low interest rates. It is also not clear that there would be any substantial investment response to lower interest rates by businesses that already are sitting on huge amounts of retained earnings. Heavily indebted consumers are also not likely to substantially boost consumption.

The trade route also does not look especially promising. If interest rates fell in the United States it is unlikely that it will lead to much of a decline in the dollar in a context where it has been pushed up by a flight to safety in uncertain times. Furthermore, it is not clear that the United States will be able to increase its net exports by much at a time when every other country is trying to go the same route and is also constricting demand through fiscal contraction.

See, economics really isn't hard.