By Simon Johnson. Tim Geithner and Larry Summers are talking a good game on fiscal policy to the G20. But they are struggling with to establish traction for their “spend now, consolidate later” message. Fortunately, there is an easy and obvious opportunity to establish credibility on this issue: Bring Paul Krugman into government.
Earlier this week, Peter Orszag resigned from his cabinet position as director of the Office of Management and Budget. The Washington Post put out one of the first lists of candidates who could replacement him. Senator Byron Dorgan would be a smart pick and some of the Post’s other suggestions could make sense.
But surely the front runner is Jason Furman. The working assumption is that Treasury Secretary Tim Geithner and National Economic Council director Larry Summers are in positions of influence for the long haul – and they have a track record of preferring team players over people who could bring competing perspectives to the table.
The Hamilton Project, housed at the Brookings Institution, was designed as a government-in-waiting by Robert Rubin. Then-Senator Obama attended its inaugural public meeting, with Peter Orszag as head of the project. Appointing Furman, successor to Orszag at Hamilton and currently a deputy to Larry Summers at the NEC, or another person from the same wing of the Clinton administration would continue in this tradition.
This is unfortunate, because the brilliant choice would be Paul Krugman – completely taking the wind out of the Republicans’ sails on fiscal deficits. Krugman has scolded them, in real-time and to great effect, consistently with regard to ruining the budget. And he has an important point – the Bush administration inherited a fairly sound fiscal position from the Clinton administration but squandered it thoroughly over 8 years.
At the same time, the Republicans allowed unprecedented system risk to develop in the big banks. To be sure, the Clinton administration shares responsibility for excessively deregulating financial institutions and derivatives – a point that even President Clinton now concedes. But the rather more pointed partisan point is that the contingent fiscal liability posed by an out-of –control financial system became much larger during the Bush years.
The purely fiscal damage wrecked by big banks – apparent in 2008 but building for longer – will end up increasing our net government debt held by the private sector by around 40 percentage points of GDP. That’s the likely final cost of the “automatic stabilizers” (i.e., tax revenue falls and we spend more on unemployment benefits during a recession) plus the discretionary fiscal stimulus that was undertaken with the – entirely reasonable – goal of preventing a Second Great Depression in early 2009. Around half of our existing government debt burden and much of our continuing fiscal vulnerability is due to the dangers posed by unreformed big banks.
Vice President Dick Cheney is famously associated with the catch phrase, “deficits don’t matter.” Yet “cut budget spending now” and “President Obama is fiscally irresponsible” are the slogans that come increasingly from Cheney’s part of the political spectrum. It would be a great move to give Krugman (and his Nobel Prize) the OMB podium from which to respond. Even the confirmation hearing would be fiery and memorable – and get the right points across.
Krugman embodies exactly the balance of messages required to be an effective budget director today. He fully understands the need for budget consolidation eventually – after all, he wrote the original definitive work on balance of payments crises and how these are fueled by money creation (and implicitly by budget deficits). No one has better anti-deficit credentials for the long haul. And, as one of the world’s leading economists on international issues, he understands better than most both the advantages granted the United States because we issue one of the few “reserve currencies” (held by private investors and central banks alike as a safe haven).
He also knows that if we don’t put our public debt eventually on a stable path, we could lose our reserve currency status – in which case our problems would begin to resemble much more those of Greece. Greece has substantially higher debt relative to GDP than we do (they are over 100 percent of GDP, on their way to 140 percent; we’re crossing 60 percent, on our way to 80 percent), and its budget deficit looks more intractable. But the ultimate difference is that when the world’s financial markets look scary and investors want to duck for cover – they run into US government obligations, and away from paper issued by governments such as Greece.
The trick, therefore, is absolutely not to engage in overly rapid fiscal contraction. This is what President Obama is warning the G20 against – although so far with little effect. The new British government, for example, seems keen to engage in excessively precipitate spending cuts and tax increases.
We need instead to set achievable medium-term fiscal targets that will stabilize our debt levels. If these are credible, this gives us the space and time we need to put our fiscal house in order without experiencing the kind of fiscal austerity that would only make our current high unemployment problems worse.
To give Peter Orszag and his colleagues – such as Tim Geithner – credit, they have tried to get this message across. But unfortunately, they have not had the stature, the top-level political support, or the kind of voice needed to really pull off what is, after all, a delicate balance that must be explained far and wide with great credibility.
The danger is that the next budget director will too much lean towards the prevailing – and incorrect – Wall Street “wisdom” that we need Southern European style austerity and now.
If the president wants to actually make progress his broader agenda, and to experience anything other than austerity and prolonged high unemployment, Paul Krugman would be the best choice for budget director.
An edited version of this post appeared this morning on the NYT’s Economix. It is used here with permission and if you would like to reproduce the entire article, please contact the New York Times.