Monday, December 01, 2008

Passing the Buck

Should we worry about government debt and future generations when devising fiscal policies to rescue the economy from it short-run troubles? In particular, should these concerns lead us to a smaller fiscal expansion than we might otherwise pursue?

Some economists, such as Dean Baker and Paul Krugman, argue the answer is no. Worries about the budget deficit, in their view, should not deter fiscal expansion. In essence, they say that future generations would be even worse off if we live through a period of depressed aggregate demand, high unemployment, and consequently reduced investment.

In my view, these arguments are cogent only under the maintained assumption that there is no good alternative to fiscal expansion. If our only choice is between (a) full employment with a large budget deficit and (b) depression without a large structural budget deficit, then by all means let's choose (a).

But I continue to believe that there are other choices. Typically, these put monetary policy front and center. As I pointed out in an earlier post, based on data Paul put together, some measures of long-term real interest rates are still high. The Fed can work to get those down and expand private investment.

To be sure, that requires nonstandard monetary actions by the Fed. At this point, simply focusing on the current target for the federal funds rate is not enough. The best thing to read about this topic is a speech Ben Bernanke gave in 2002. As I noted in my most recent Times column, the Fed is now engaging in the sort of creative monetary policy Ben talked about six years ago.

One thing all economists agree on: If there are public investment projects that pay a high rate of return, those are worth paying for, even if it means more borrowing. But that is always true. Even if we were at full employment and there were no possible employment effects of fiscal stimulus, we should undertake public investments that pass a cost-benefit test.

In this regard, two observations come to mind. First, since most infrastructure is used locally, the proper level of spending is best determined by state and local governments rather than by the federal government. Earlier, I suggested that fiscal stimulus could be decentralized. Each state governor could be allowed to determine whether to take federal money as state aid or have it paid directly to his or her state's citizens as tax relief. I still think that makes sense.

Second, more public projects would pass a cost-benefit test if we repealed the Davis-Bacon Act. This law requires contractors on these public projects to pay "prevailing wages," which are typically union wages well in excess of what would occur in a free market. If the government paid market-determined wages for infrastructure projects, we could have both more infrastructure and less government debt. Without doubt, that legacy would benefit future generations.