Now, although I don’t necessarily agree with Kevin Hassett’s prescriptions, I can understand his feeling that the “paradox of thrift” argument for more government spending seems a bit strange in the case where public and private debt are elevated.
Fundamentally, I believe that all the debate stems from different peoples view of “the natural rate of output”.
If we completely believe the CBO potential output projections (which I do not) then we are in a hole – and there is a DEFINTE and URGENT case for a fiscal stimulus. I am more than willing to concede that.
However, if potential is a lot lower (either because we have been running past, or because it has been “hammered” by recent supply side shocks), then the current pull back in spending by agents is rational and should be allowed to happen. If the government can help the transition (eg by pushing the real wage to adjust and/or by helping unemployed people “upskill”) then there could well be a case for that – but not for an indiscriminate fiscal stimulus.
Lets take today’s discussion of household wealth as an example. Households in the US based spending patterns on a estimated lifetime wealth level that included increases in real house prices. However, real house prices have plummeted. This is a real reduction in consumers lifetime spending power – and so should be match by a marked reduction in household spending.
If consumers now feel that they are borrowing to much we have to let them save – or else we will just be making them worse off. Is there a cost to this savings behaviour, YES. But having the government tax (in the future) and spend people money for them in isn’t going to magically make things better.
The current crisis is the result of a huge change in expectations which can only occur in the case of both imperfect and asymmetric information among agents. With such a wide ranging market failure there are definitely ways that government can help – however, appealing to the “paradox of thrift” for arbitrary government spending is not one of them.