Tuesday, October 21, 2008

Fiscal stimulus and the budget deficit / fiscal gap

Paul Krugman is among those mocking the idea that we need to worry about the long-term fiscal situation given the risk of severe recession and the need for fiscal not just monetary policy to address it.

Okay, I'm on board for fiscal stimulus this time around, although I don't like it in general because I think politicians tend to misuse it in other circumstances as an excuse for whatever they happen to want to do (e.g., the Bush 2003 tax cuts) and because it is used asymmetrically for the down cycles only. But I recognize that this may be one of those "Break glass in emergency only"-type moments.

Still, the response to the financial crisis is beginning to remind me of one of the perversities of how budget policy responded to 9/11. True, when 9/11 happened, we (a) needed to increase spending for Afghanistan and domestic security and (b) would have been ill-advised to implement immediate tax increases to pay for the extra spending. But there was no reason, apart from politics, not to enact deferred financing. Fundamentally, 9/11 indicated that we would have a larger long-term fiscal problem than was previously expected, yet it played out politically on the ground as if it meant that budgetary concerns could now be completely ignored. (Recall that, right before it happened, the "lockbox" question of whether Social Security surpluses were ostensibly being used to pay for current spending was at political center stage.)

The current financial crisis likewise indicates that, in the long run, our fiscal problems are larger, not smaller, than we previously believed. So it is vital to think about long-term fiscal problems even though big short-term deficits may make sense.

Krugman is blind to this because he insists that "[w]e don’t have an entitlement crisis — we have a health care crisis, one of whose manifestations is high projected costs for Medicare and Medicaid."

I just don't get this. Isn't it both? Consider a Venn diagram with one circle for the healthcare crisis and another for the fiscal gap. The two circles overlap a lot, reflecting the relationship that Krugman notes. But they also have non-overlapping aspects (privately funded healthcare problems for the one, Social Security & tax cuts & all the rest for the other). And the overlapping portion truly is both - not just one of them.

Why would one look at such a Venn diagram and say that only one of the two circles is actually there?

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