How to Boost Growth While Reducing the Deficit

Noam Scheiber’s article on the Obama administration’s dilemma as it tries to pair the dual imperatives of job-creation with deficit control is pretty disturbing. In particular, it suggests an administration that’s started to internalize some of the political constraints on fiscal expansion. To review, back last year Christina Romer told her colleagues that something like $1.2 trillion in fiscal stimulus was needed. For political reasons, that was scaled down to something more like $800 billion. The Senate then scaled that back to something more like $700 billion. So the day Barack Obama signed ARRA, his administration’s analysis suggested that $500 billion in additional stimulus would be a good idea. Then it turned out that the winter of 2009-2010—which basically all happened before the stimulus went into effect—featured a much sharper contraction than had been expected.

So it’s very strange to learn that members of the Obama administration economic team have started to feel that the deficit is too big, when their analysis strongly suggests that it’s much too small. They say they’re worried about the bond market, but the nice thing about the bond market is you can just go look it up and there’s no problem there:


Whatever reason you might have for worrying more about the deficit than you did three years ago, it can’t be the bond market. The bond market is telling you to worry less.

All that said, there is a way to create jobs and reduce the deficit. It’s to persuade the Federal Reserve Open Market Committee to implement the Gagnon Plan for additional quantitative easing. In an ideal world, the European Central Bank, the Bank of Japan, and the Bank of England could also be persuaded to follow Gagnon’s outline. His proposal to have the Fed buy $2 trillion in government bonds, with an average maturity of 7 years, would increase the GDP growth rate. That would make tax revenues higher. It would also increase the level of employment, reducing the need for outlays on unemployment insurance, Medicaid, SNAP, etc. That reduces the deficit.

If monetary easing has such magic properties, why don’t we do it all the time? We don’t do it all the time because we often worry about inflation. But right now inflation is extremely low and core inflation is expected to decline. If inflation were higher than it is right now, we’d be hitting our inflation target. That’s doesn’t sound so bad. If inflation were a bit higher than that, we’d be returning to the long-run price level trend. That doesn’t sound so bad either. And we’d have a more prosperous country, with fewer jobless people and a lower budget deficit. That nobody outside the blogosphere is even talking about this possibility is extremely frustrating.