Stimulus now can ease debt burden later: DeLong and Summers

March 23, 2012

Spend more now, save more later. It may sound somewhat counterintuitive, but it’s the best prescription for getting out of deep economic ruts, according to a new paper from Bradford DeLong and Lawrence Summers, former economic policymakers now in academia.

In particular, the economists focus on the notion of hysteresis, which is a state where a prolonged period of economic retrenchment and high long-term unemployment creates new types of structural barriers to reintegrating the jobless back into the labor market. It thereby does lasting damage to the economy’s potential rate of growth.

Against this backdrop, DeLong and Summers argue a highly stimulative fiscal policy can actually reduce the long-term debt burden. They argue vigorously against policies of austerity, saying they are self-defeating and ultimately may actually worsen a country’s debt profile.

Our analysis simply demonstrates that additional fiscal stimulus, maintained during a period when economic circumstances are such that multiplier and hysteresis effects are significant and then removed, will ease rather than exacerbate the government’s long run budget constraint. […]

While our analysis underscores the importance of governments pursuing sustainable long run fiscal policies, it suggests the need for considerable caution regarding the pace of fiscal consolidation in depressed economies where interest rates are constrained by a zero lower bound.

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