Damned if they do and damned if they don't

by Ed Bowsher on 24 August 2009  |  0 comments
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Economic policymakers face a really tough decision. When should they turn off the fiscal and monetary stimulus taps? It's tough, but there's not much that most of us can do. So we might as well sit back and enjoy a bitchy contretemps between two denizens of the op-ed pages.

I enjoyed this 'Sunday Times' article about a spat between two of the leading media-savvy academics in the US and UK. Arguments between intellectuals can be particularly entertaining and bitchy, and there's some cracking stuff in the article.

But behind the insults, there's an important debate.

On one side you have Paul Krugman, Professor of Economics at Princeton and left-wing columnist (by US standards) for the 'New York Times.' Krugman believes that the fiscal stimulus has been a crucial weapon in fighting the economic crisis and must continue for some time to come.

On the other, there's Niall Ferguson, Professor of History at Harvard and writer/presenter of 'The Ascent of Money.'  Ferguson is more sceptical about the value of the stimulus and thinks it's time to stop spraying government cash around in the name of good economic management. He worries that if the UK and US governments carry on borrowing at their current rate, there's a danger that the financial markets will take fright and become very reluctant to fund those government deficits. Interest rates could then spiral.

So who's right?

Well, in a way, I think they're both right. Yes, there is a danger that governments will find it hard to carry on borrowing at current levels. On the other hand, if the fiscal taps are turned off, there's a real chance that we could slide into a global slump.

Nouriel Roubini - aka 'Dr Doom' - outlines the dilemma very well in today's FT:

'Policymakers are damned if they do and damned if they don't. If they take large deficits seriously and raise taxes, cut spending and mop up excess liquidity soon, they would undermine recovery and tip the economy back into stagdeflation (recession and deflation.)

But if they maintain large budget deficits, bond market vigilantes will punish policymakers. Then, inflationary expectations will increase, long-term government bond yields would rise and borrowing rates will go up sharply, leading to stagflation.' [recession and inflation.] 

What about me?

I can't claim to be as learned or distingushed as any of the above-mentioned gurus, but I lean towards the Krugman position. Given a choice between recession and inflation, or recession and deflation, I'd choose the former. Central bankers have plenty of experience of choking off inflationary surges over the last 40 years, and it should be doable in a couple of years. But the experience of Japan since 1989 shows that it can be really tough to get out of a deflation-led recession.

Of course, I could be wrong. I accept that If the bond markets got really, really angry about the levels of government borrowing, things could get very unpleasant.

As Dr Doom says: policymakers are damned if they do, and damned if they don't.