Taking the German Constitutional Court Seriously

Given the many flaws in the controversial ruling by Germany's Federal Constitutional Court against the European Central Bank, it is tempting to dismiss the decision as yet another instance of German obstructionism. But either through persuasion or reform, Germany's longstanding complaints will have to be addressed.

Marcel Fratzscher


fratzscher16_Uli Deckpicture alliance via Getty Images_germanfederalconstitutionalcourt


BERLIN – The German Federal Constitutional Court’s (GCC) ruling against the European Central Bank’s pre-pandemic asset-purchase program has stunned policymakers and other observers outside of Germany. Many will be tempted either to ignore the ruling altogether, or to escalate the legal battle with the GCC.

But both approaches would be counterproductive. The situation calls for an earnest debate about the ECB’s mandate and existing European treaties.

Specifically, the GCC has accused the ECB of breaching the Treaty on the Functioning of the European Union by not conducting a proper “proportionality assessment” for its Public Sector Purchase Program. The court regards the PSPP as more than a monetary-policy tool.

It is a broader economic policy that has imposed undue costs on small savers, taxpayers, and individual sectors. As such, the GCC believes that the ECB has approached or already crossed the line of extending prohibited monetary financing to member-state governments.

While this is not the first time that the GCC has gone after the ECB, the latest ruling certainly constitutes an intensification of the conflict. In the absence of a proportionality assessment from the ECB, the Bundesbank will be prohibited from participating in the PSPP, with potentially far-reaching implications for Europe’s Economic and Monetary Union (EMU).

There is much to criticize about the ruling, not least its failure to understand the economics of monetary policy. The ECB does, in fact, conduct a regular, broad assessment of the implications of its policies each time it publishes quarterly projections. Moreover, price stability is not attainable in an economy where savers have been disowned, zombie firms are flourishing, and the banking system has collapsed.

By demanding that the ECB offer the kind of assessments that it requires, the GCC is provoking a dangerous clash between European and German law. It is not surprising that many economists and legal scholars have described the GCC’s arguments as utter nonsense.

Nonetheless, European institutions must take the GCC’s challenge seriously, or catastrophic consequences could follow. Given that the GCC has long been on a mission to challenge the ECB’s policies, there is no reason to assume that it will stop with this latest ruling. More important, one cannot ignore the fact that the court’s arguments resonate with many German economists, politicians, and voters.

Across the German mainstream, there is a deep conviction that the ECB does not act in Germany’s best interest. Especially since the 2008 global financial crisis, a growing chorus has criticized not just the ECB’s bond-purchase programs, but also its interest-rate and collateral policies, and even its TARGET2 payment system.

This intensifying public sentiment has steadily eroded the ECB’s credibility in Germany. That is not a problem that can be brushed aside. Trust and credibility are a central bank’s most important assets, without which it cannot fulfill its mandate. The EU and other member-state governments therefore can no longer ignore the GCC and the constituency it speaks for.
 
As a first step, the ECB needs to understand what the GCC (and the German public) expects from it. The court’s complaint that existing monetary policies impose costs on specific groups implies that it doesn’t think price stability should be the ECB’s primary objective. The GCC is essentially demanding that the ECB pursue a different mandate.

To be sure, the GCC has no authority to demand such a change. But, to avert a deeper crisis, the ECB needs to convince the German public that price stability is its primary objective for a reason, and that it cannot simply decide to discipline certain governments or favor policies that would benefit German savers and banks. This issue will not be resolved through the ECB’s standard strategy review process.

The GCC also objects to the risk-sharing element that is inherent in all ECB policy decisions. Monetary policy always will have distributional consequences within societies, and, in the eurozone, across countries.

But the German mainstream view is that ECB policies since 2008 have been designed to benefit weaker southern European countries at Germany’s expense. Again, it may be tempting to dismiss this argument as nonsense (which it is), and to point out that Germany has benefited as much as others from ECB policies over the past decade. But that will not resolve the conflict.

After all, the ECB has assumed an extraordinary degree of responsibility for maintaining economic and financial stability – first during the 2008 crisis, then during the subsequent European debt crisis, and now in response to COVID-19.

With a proper fiscal and capital-market union to strengthen risk sharing, divergences within the eurozone could be reduced, allowing the ECB to step back from sovereign bond purchases and other interventions. But this probably won’t happen any time soon, which means that the ECB would do well to adjust its strategy.

The ECB should revise its definition of price stability and its method of analyzing the implications of monetary policy, not to please the German court, but to enhance transparency.

For now, at least, that could help protect its operational, institutional, and legal independence.

But in the long term, the EU and member-state governments cannot ignore the German position. Despite several serious weaknesses and contradictions in its reasoning, the GCC raises legitimate and important issues concerning the ECB’s monetary-policy mandate and its role within the EMU.

In the best-case scenario, the EU will take the GCC’s ruling as a wake-up call to work toward a viable fiscal and capital-market union, and to clarify the ECB’s role therein. That will require a maddeningly difficult EU treaty change. But the alternative would be far worse.


Marcel Fratzscher, a former senior manager at the European Central Bank, is President of the think tank DIW Berlin and Professor of Macroeconomics and Finance at Humboldt University of Berlin.

People cannot just be ordered back to work and to spend

It seems foolish to imagine the UK will swiftly return to life as it was before Covid-19

Martin Wolf

PABest **Parental permission granted** Two families maintain social distancing while talking to each other outside a home in Hampstead, north London, as the UK continues in lockdown to help curb the spread of the coronavirus. PA Photo. Picture date: Sunday May 3, 2020. See PA story HEALTH Coronavirus. Photo credit should read: Victoria Jones/PA Wire
Avoiding a spike must mean distancing measures of some kind will continue far beyond September 30 © Victoria Jones/PA


The UK government is planning how, and how quickly, to end the lockdown. This necessitates a complex and interlocking set of decisions taken under huge uncertainty.

In making them, the government must realise it has a poor record of managing Covid-19 so far.

It has to do much better.

The UK’s recorded rate of death per million, almost certainly an underestimate, is the fourth highest among its peers, with only Italy (just), Spain and Belgium ahead. That is so even though these countries suffered the pandemic’s onslaught before the UK. This should have given Britain time to recognise the dangers and respond effectively. Am I surprised by the failure?

Not really.

A large number of people believe that, in order to protect the economy, the sensible thing to do was — and still is — to impose few or no restrictions on individual behaviour, other than to tell the most vulnerable to stay at home. Yet countries that refused to impose tight controls such as Sweden and the Netherlands are not now forecast to do better economically.

They have had far more deaths than peers such as Austria, Denmark, Finland, Germany or Norway. Yet their growth prospects, at least for now, are not expected to be any better. The assumed trade-off between suppression of the virus and the health of the economy, in the medium term, is illusory.

The Bank of England’s latest forecast of a 14 per cent contraction of gross domestic product this year followed by a 15 per cent expansion in 2021 assumes that “social distancing measures and government support schemes” remain “as they are until early June, before being gradually unwound” by the end of the third quarter.

It also assumes very little “scarring” of the economy from the output collapse now under way.

Alas, these assumptions look optimistic. Another big spike in infections would certainly make its forecast recovery seem inconceivable. But avoiding such a spike must also mean that distancing measures of some kind will continue far beyond September 30.

Chart showing a weak link between death rates and forecast economic growth this year – deaths per million (May 6 2020) and 2020 forecast GDP growth (%, May 4 2020)


Getting people back to work, an excellent study from the Institute for Fiscal Studies, brings out the many obstacles to any such early return to normality.

First, uncertainty will not disappear.

Second, the impact of the virus on supply and demand for goods and services will be highly heterogeneous. On the supply side, work that demands face-to-face contact or co-operation will continue to be more affected than work that can be done at a distance.

The same will be true of the pattern of demand. Third, the impact on the labour supply and on would-be purchasers is also going to be heterogeneous, with the young able to operate much as before and the older and those with health conditions far less so. Fourth, even this ignores the complex impact from the world economy.

An obvious implication is that the structure of supply, demand and available work will alter radically throughout the epidemic.

This makes the BoE’s assumption of a smooth economic rebound more implausible. It will also complicate the withdrawal or modification of government support programmes. A further implication is that the effects on different groups will remain unequal.

Yet another is that government and business will have to find ways to reassure workers and customers.The close links among different groups of workers will be particularly hard to manage. Getting parents back to work demands the reopening of schools. That means enticing teachers back to work, too.

Getting the young back to work requires the presence of older supervisors and managers.

Should non-key-workers go out freely if that puts their partners at risk? The report clarifies these complexities — and many more.

The UK is only at the end of the beginning. It was not a good start either. It seems foolish to imagine the country will swiftly return to life as it was before Covid-19.

Things will remain different. Our least bad future seems to be one in which the disease is suppressed until a vaccine arrives. In the meantime, testing, tracking and quarantine will be required, and government, business and worker representatives will need to make plans that allow as much of the economy as possible to reopen, while protecting the health and livelihoods of the physically and economically vulnerable.

It is one of the most complex tasks government has ever attempted. No doubt, there will be surprises.

But this time, it really must be thought through.

The Medical Structure and Calculated Risk

By: George Friedman


Medical research is always involved in the important work of understanding disease and the human body. It is now at the center of a global crisis whose evolution can define the international system, the internal systems of nation-states and the shape of our lives.

The medical system is no longer vital only to the management of disease but also to the future of humanity.

This statement will seem hyperbolic. I don’t think it is.

Unlike other global crises, like the threat of nuclear war or the possibility of global warming, COVID-19 threatens to fundamentally disrupt civilizations, and unlike these other existential crises, how it evolves depends on the successes and failures of medical research.

Like the military or the financial system, the medical system is a social system. It is a substantial establishment, in the United States but also in many other countries. It has fought battles against devastating diseases such as polio, HIV, heart disease and the like. It sometimes succeeds, it sometimes fails and it sometimes falls in between.

It conducts its battle with patient research, and expending time in order to prevent doing harm.

It is not at the center of society usually, but at the points where many of us will live or die. In the United States, the establishment is part government and part private. In that way, it tracks with other institutions.

The arrival of COVID-19 was unexpected. It arrived in China sometime in early winter and migrated throughout the world, if the current narrative is true. For all we know it may have been lurking in the dark corners for decades. The political system will of course engage in a debate about who should have known what and when, hoping to find a person or country to hold responsible for our misery.

The function of the political system is to stabilize all the other systems, and one of its means, odd though it might seem, is to personalize the responsibility for all things. Nothing just happens.

Someone had to be responsible. This stabilizes the system because it reassures people that we are in control of our lives. Even if someone failed to do his job and must pay, it is reassuring to know that someone could have been in control. However, the fact is that thinking that an elected official would have any idea of what to do with this disease is preposterous.

It is preposterous because the medical institution, the one that is responsible and knowledgeable in such things, hasn’t been able to come to grips with it. It is said that some have forecast such a pandemic for years. A forecast such as that is useless, which I as a forecaster have the right to say.

Without some sense of when and what, no action is possible. But the forecaster can claim prescience, when it is merely the fact that a broken clock is right twice a day.

It is the medical system that was charged with protecting us from this disease. No institution can possibly be infallible, and each is limited by its knowledge and culture. The medical research establishment did not understand the nature of the disease. It still is uncertain whether catching the disease provides immunity or whether we will spend our lives in endless recurrence.

It has at the moment no treatment that might mitigate the disease nor any that might prevent it. The culture that medical research has presented and projected to the world is that it is intensely at work, but that its work cannot be time-sensitive. It cannot be hurried, but its process must take its course.

This is not an unreasonable standpoint, but it has consequences. The only solution the medical system had was to prevent the spread of the disease by sequestration, the separation of individuals from each other. This may have had some mitigating effect on the disease, but it is having a disastrous effect on society. It is not hyperbolic to say that we are heading for a depression.

The best available medical solution reduced the available labor force, reduced consumption and in many countries forced extravagant government infusions of money, infusions for which we will pay later. A depression is a disease in its own right. Poverty and despair cause their own deaths, but it is the loss of expectations and hopes that is the highest cost. I say we seem to be heading toward depression, not that we are there. Still, the danger is there and it is not trivial.

The mitigation of the spread of the disease has, apart from the social pressures of sequestration, generated a significant economic crisis. The response has been myriad decisions based not on certainty but on calculated risk.

The government does not know that the trillions of dollars to stabilize the economy will abort a depression, but it does know that the cost of a depression justifies taking a risk and racking up debt.

Each of us, in some small or large way, has engaged in calculated risk.

The moral foundation of medicine is that it must, first of all, do no harm. By “harm” it means that no action of the physician or the researcher should harm the patient. This imposes a meticulous discipline on medicine. No drug is released until it is certain that it will do no harm.

This requires meticulous testing and evaluation, and that takes time. Part of the medical research process is imposed by the complexity and mystery of the subject. Part of it is due to the moral aversion to risk. And that aversion to risk can turn a virtue into a vice.

The medical profession cannot eliminate risk, but doing no harm makes it a moral imperative.

Other systems operate not on a zero-risk principle but on the principle of calculated risk.

Defining this principle is difficult because it is both constantly shifting and different from structure to structure. In finance, calculated risk is the moral norm, although error can have devastating effects on people.

Certainty is impossible. Refusing to act carries its own risks and costs. In a military operation, where it is a matter of life and death, the risk is calculated with care, but so is the consequence of inaction.

Most important for both is time. The opportunity or danger shifts its shape continually. Time is a precious commodity that has to be measured and spent prudently. Time and risk are intimately linked, and human beings are constantly searching, however imperfectly, for the balance. At certain points, it is a moral or practical imperative that risk must be taken, even if it might cause harm. This dynamic defines our lives.

Medical research is bound not to inflict harm. As a result, there is a constant search for moving “a medication might help” to “a medication will help and won’t cause harm.” The distance between the first and the second can be months or years.

The issue is the difference between “probably” and “certainly.” The medical aversion to “probably” will limit the harm done by the researchers and physicians. But the time between probably and certainly carries its own, possibly devastating cost.

The longer the pandemic continues, the greater the harm it does. In refusing to incur risk, the medical system imposes heavy costs.

In most structures, there are normal operations and emergency operations. What takes a year in the military in normal times might be done in a week in an emergency. In most structures, an emergency means the acceptance of a degree of failure that would not be acceptable otherwise in order to gain time. In the military, such shortcuts may well cause deaths, even to civilians.

But not taken, these risks certainly increase deaths.

Time is of the essence, and no one will claim that the medical profession is wasting time. But by not adopting the principle of calculated risk, by not accepting that sometimes a hoped-for cure will do some harm, it guarantees that the death toll will mount.

Some 80,000 Americans, and hundreds of thousands more elsewhere, are dead. More will die. There is a saying that the perfect is the enemy of the good. In a way, that is at the heart of calculated risk, and calculated risk is at the heart of life.

Certainty carries with it a cost and uncertainty carries a risk.

Extensive testing of potential treatments is imperative in normal times. These are far from normal times. People will die from a failed medication. But people are dying without a medication. “Do no harm” is an admirable and desirable principle.

But moral absolutes may not be as useful right now as the principle of calculated risk.

No One Knows What’s Going to Happen

Stop asking pundits to predict the future after the coronavirus. It doesn’t exist.

By Mark Lilla

                                 Credit...Javier Jaén



The best prophet, Thomas Hobbes once wrote, is the best guesser. That would seem to be the last word on our capacity to predict the future: We can’t.

But it is a truth humans have never been able to accept. People facing immediate danger want to hear an authoritative voice they can draw assurance from; they want to be told what will occur, how they should prepare, and that all will be well. We are not well designed, it seems, to live in uncertainty. Rousseau exaggerated only slightly when he said that when things are truly important, we prefer to be wrong than to believe nothing at all.

The history of humanity is the history of impatience. Not only do we want knowledge of the future, we want it when we want it. The Book of Job condemns as prideful this desire for immediate attention. Speaking out of the whirlwind, God makes it clear that he is not a vending machine. He shows his face and reveals his plans when the time is ripe, not when the mood strikes us. We must learn to wait upon the Lord, the Bible tells us. Good luck with that, Job no doubt grumbled.

When the gods are silent, human beings take things into their own hands. In religions where the divine was thought to inscribe its messages in the natural world, specialists were taught to take auspices from the disposition of stars in the sky, from decks of cards, dice, a pile of sticks, a candle flame, a bowl of oily water, or the liver of some poor sheep. With these materials, battles could be planned, plagues predicted and bad marriages avoided.

In those places where the gods were thought to communicate verbally with humans, oracles and prophets were designated to provide answers on demand. The most highly revered oracles in the ancient Greek world were the high priestesses at the Temple of Apollo at Delphi. When it came time to respond to a petitioner who had placed a question before her, the priestess would enter the inner sanctum and seat herself on a tripod erected over a crevice in the ground, out of which inebriating gases were thought to rise.

These fumes paralyzed her rational faculties and put her in a trance of receptivity that allowed the god Apollo to speak through her in cryptic remarks and riddles. These would be interpreted by a second figure, the prophet, who answered the grateful petitioner in poetry or prose. It was a very successful start-up and made Delphi a wealthy town.

Prophets today are less flamboyant. Former prime ministers do not, as a rule, sniff drugs before appearing on CNN. They sit meekly in the green room sipping mineral water before being called on to announce our fate. Augurs have given up on sheep livers and replaced them with big data and statistical modeling. The wonder is that we still cry out for their help, given that the future is full of surprises.

Professional forecasters know this about the future, which is why in the small print of their reports they lay out all the assumptions that went into the forecast and the degree of statistical confidence one might have in particular estimates, given the data and research methods used. But harried journalists and public officials don’t read or comprehend the footnotes, and with the public baying for information, they understandably pass on the most striking estimates just to get through the day.

Ancient augurs and prophets were in high-risk professions. When their predictions failed to materialize, many were executed by sovereigns or pulled apart by mobs. We see a bloodless version of this reaction today in the public’s declining confidence in both the news media and the government.

Take a banal example: snowstorms and school closings. A half century ago, when meteorological forecasting was less sophisticated, parents and children would not learn that classes were canceled until the storm began and it was announced on radio and television that very morning. We lived in harmless uncertainty, which for kids was thrilling. When snowflakes fell they even looked like manna from heaven.

Today, mayors and school superintendents, putting their faith in the meteorologists, routinely announce closings a day or more in advance. If the storm fails to arrive, though, they are sharply criticized by parents who lost a day of work or had to find day care.

And if an unforeseen storm paralyzes the city, leaving streets unsalted and children stranded at school, the reaction is far worse. More than one mayor has lost a re-election bid because of failed prophecies, victim of our collective overconfidence in human foresight.

Credit...Javier Jaén



Our addiction to economic forecasting is far more consequential. Here the footnotes really do matter but politicians and the press encourage magical thinking.

The candidate declares, My plan will create 205,000 new jobs, raise the Dow 317 points and lower the price of gasoline 15 cents. Two years later, the gloating headline reads: The President’s Unkept Promises. Stagnant growth, a bear market and war in the Middle East make re-election unlikely.

Never mind that declining global demand slowed growth, that Wall Street is a drama queen and that a freakish tanker collision set off the war. A failed presidency is declared. And so the press and the public turn to fresher faces — who of course offer the same absurdly precise predictions. Not for nothing did Gore Vidal call us the United States of Amnesia.

The public square is thick today with augurs and prophets claiming to foresee the post-Covid world to come. I, myself, who find sundown something of a surprise every evening, have been pursued by foreign journalists asking what the pandemic will mean for the American presidential election, populism, the prospects of socialism, race relations, economic growth, higher education, New York City politics and more. And they seem awfully put out when I say I have no idea. You know your lines, just say them.

I understand their position. With daily life frozen, there are fewer newsworthy events to be reported on and debated. Yet columns must be written, and the 24/7 cable news machine must be fed. Only so much time can be spent on the day’s (hair-raising) news conferences or laying blame for decisions made in the past or sentimental stories on how people are coping. So journalists’ attention turns toward the future.

But the post-Covid future doesn’t exist. It will exist only after we have made it. Religious prophecy is rational, on the assumption that the future is in the gods’ hands, not ours. Believers can be confident that what the gods say through the oracles’ mouth or inscribe in offal will come to pass, independent of our actions. But if we don’t believe in such deities, we have no reason to ask what will happen to us. We should ask only what we want to happen, and how to make it happen, given the constraints of the moment.

Apart from the actual biology of the coronavirus — which we are only beginning to understand — nothing is predestined. How many people fall ill with it depends on how they behave, how we test them, how we treat them and how lucky we are in developing a vaccine.

The result of those decisions will then limit the choices about reopening that employers, mayors, university presidents and sports club owners are facing. Their decisions will then feed back into our own decisions, including whom we choose for president this November. And the results of that election will have the largest impact on what the next four years will hold.

The pandemic has brought home just how great a responsibility we bear toward the future, and also how inadequate our knowledge is for making wise decisions and anticipating consequences. Perhaps that is why our prophets and augurs can’t keep up with the demand for foresight.

At some level, people must be thinking that the more they learn about what is predetermined, the more control they will have. This is an illusion. Human beings want to feel that they are on a power walk into the future, when in fact we are always just tapping our canes on the pavement in the fog.

A dose of humility would do us good in the present moment. It might also help reconcile us to the radical uncertainty in which we are always living. Let us retire our prophets and augurs.

And let us stop asking health specialists and public officials for confident projections they are in no position to make — and stop being disappointed when the ones we force out of them turn out to be wrong. (A shift from daily to weekly news conferences and reports would be a small step toward sobriety.)

It is bad enough living with a president who refuses to recognize reality. We worsen the situation by focusing our attention on litigating the past and demanding certainty about the future. We must accept what we are, in any case, condemned to do in life: tap and step, tap and step, tap and step ….


Mark Lilla is a professor of humanities at Columbia and the author, most recently, of “The Once and Future Liberal.”

The case for permanent stimulus

Paul Krugman 

Policymakers are frantically trying to come up with a policy response to the Covid-19 crisis. This column, taken from a recent Vox eBook, argues that there is a very good case for putting a sustained, productive programme of stimulus in place as soon as possible, instead of scrambling to come up with short-term measures every time bad things happen.


Let’s be clear: we knew, or should have known, that something like COVID-19 was going to happen.

I don’t mean that we should have expected a pandemic, although public health experts have been warning about the likelihood of such an event for years. What I mean is that we should have known that sooner or later — and probably sooner rather than later — we would face an adverse economic shock that conventional monetary policy couldn’t offset. As I liked to put it, I didn’t know when we’d hit the next major bump in the road, but when it did come, we’d discover that our shock absorbers were shot.

So now we’ve hit that bump, taking the form of a pandemic, and policymakers are frantically trying to come up with a policy response. I will not, however, weigh in on immediate measures, except to say that the case for fiscal stimulus is overwhelming.

What I want to propose, instead, is a long-term policy that will make it easier to handle future bumps in the road. I’ll make the recommendation for the US, but similar logic applies to the advanced world as a whole.

So, here we go:

• I hereby propose that the next US president and Congress move to permanently spend an additional 2% of GDP on public investment, broadly defined (infrastructure, for sure, but also things like R&D and child development) — and not pay for it.

Let me explain why this would be a prudent and productive thing to do.

Living with low interest rates

A dozen years after the global financial crisis, we’re still living in a world of very low interest rates. At this point it’s clear that low rates are the new normal; that is, we’re in an era of secular stagnation.

Larry Summers gave his seminal speech reviving concerns about secular stagnation back in 2013, yet even now many people seem confused about the concept. It doesn’t mean that the economy never grows, or even that it’s always depressed. It means, instead, that on average the ‘natural’ interest rate — the rate consistent with full employment — is very low.

There can still be periods of full employment, when a bubble or a wave of technologically driven investment temporarily lifts the economy. But much of the time private demand is depressed enough that even a zero interest rate is insufficient to eliminate the output gap.

Figure 1 illustrates the point schematically. The curve labeled “without stimulus” shows a hypothetical course over time of the output gap that would prevail at a zero policy rate. Of course, policy rates wouldn’t always be zero; during good times, when the curve rises above zero, the central bank might raise rates and trim the peaks. But during bad times, conventional monetary policy would become impotent.

Figure 1



And these bad times appear likely to be common, indeed almost the norm. The US was in a liquidity trap for eight of the past 12 years; Europe and Japan are still there, and the market now appears to believe that something like this is the new normal.

So what do we do?

For now, we respond with a combination of unconventional monetary policy and, maybe, fiscal stimulus. But there are real doubts about the efficacy of unconventional policy and its longer-run implications. Meanwhile, the need to act quickly, even if we do act — and what we’ve seen of the politics of stimulus isn’t encouraging — limits the form of fiscal stimulus.

There’s an overwhelming case that stimulus take the form of public investment, in both physical and human capital, given low interest rates and the clear need for better infrastructure, childhood health and nutrition, and more. But such investment can’t be ramped up rapidly.

So my proposal is that we undertake large, deficit-financed public investment on a continuing basis.

The upper curve in Figure 1 illustrates what this would do. It would reduce both the duration and the depth of zero lower bound (ZLB) episodes, and ensure both that we do in fact get economic support from fiscal stimulus and that this stimulus is productive. Deficit-financed public investment might lead to some crowding out of private investment during better periods, but as Olivier Blanchard argued in his 2019 presidential address to the AEA, low interest rates suggest that the rate of return on private investment is low, so this isn’t a major concern.

What about debt?

The obvious objection to a policy of permanent stimulus is that it will add to public debt — and not that long ago, policymakers were obsessed, or claimed to be obsessed, with the dangers posed by high ratios of debt to GDP.

But those concerns were misplaced, and a look at the arithmetic of debt in an era of low interest rates suggests that permanent stimulus is entirely doable.

Let’s consider a stylised, round-number economy that I’ll call “America.” This economy currently has public debt equal to 100% of GDP. It can expect, on average, to experience nominal GDP growth of 4% a year – half real, half inflation. It can also expect, on average, to pay an interest rate of 2% on its debt. The actual numbers don’t match my example exactly — right now, growth prospects may be a bit worse than that, but interest rates are even lower. But I think this is close enough to make my point.

In the long run, fiscal policy is sustainable if it stabilises the ratio of debt to GDP. Because interest rates are below the growth rate, our hypothetical economy can in fact stabilise the debt ratio while running persistent primary deficits (deficits not including interest payments.)

Let d be the ratio of debt to GDP, b be the primary balance as a share of GDP, r and g be the interest and growth rates, respectively. Then the equation for debt dynamics is:

d = –b + (r – g)d

So in my hypothetical case, where d = 1 (debt is 100% of GDP), the debt ratio can be stabilised while running a primary deficit of 2% of GDP.

Put the interest payments back in, and this translates to a headline deficit of 4% of GDP. Our actual deficit is a bit bigger than that, but we could get back into that range by repealing Trump’s corporate tax cuts, which don’t seem to be doing anything for investment anyway.

OK, now let’s introduce a public investment programme of 2% of GDP, with no pay-fors. The debt ratio will now begin to rise, but not without limit. If nothing else changes, d will eventually stabilise at 2 — debt at 200% of GDP.

That’s terrible, right? Um, why? Don’t tell me about the burden of paying interest on the debt — that’s already taken into account by the calculation. Maybe we’d have a debt crisis, but Japan has debt exceeding 200% of GDP, with no crisis in sight.

Also, ‘eventually’ would be a long time. That little debt-dynamics equation has a convergence rate of .02, hence a half-life of 35 years. In other words, my permanent stimulus plan would raise the debt/GDP ratio to only 150% by the year 2055. That’s a level the UK has exceeded for much of its modern history.

And even 35 years is probably too long a time horizon; who knows what the world will look like that far ahead? I think a 20-year programme of public investment would count as ‘permanent’ in most peoples’ eyes. And an ‘excess’ primary deficit of 2% of GDP for 20 years would only cause the debt ratio to rise from 100 to 133% of GDP, not at all an alarming number by historical standards.

By the way, if anyone is wondering why the rise in the debt ratio would be less than the cumulative deficit spending, it’s because with interest rates below growth rates we experience the opposite of a debt spiral: instead of snowballing because higher interest rates mean bigger deficits, the debt ratio tends to ‘melt’ because higher debt means faster erosion of the ratio by growth.

Objections

OK, there is a valid objection to my argument: I’ve just implicitly assumed that permanent fiscal stimulus wouldn’t raise the interest rate, and that’s not a safe assumption. For one thing, ZLB episodes would probably be fewer and shorter than otherwise. Also, the Fed would probably raise rates a bit further than it would have otherwise during those periods when the economy isn’t in a liquidity trap.

But there would also be offsetting factors.

• First, when the economy is in a liquidity trap, which now seems likely to be a large fraction of the time, the extra public investment will have a multiplier effect, raising GDP relative to what it would otherwise be.

Based on the experience of the past decade, the multiplier would probably be around 1.5, meaning 3% higher GDP in bad times — and considerable additional revenue from that higher level of GDP. Permanent fiscal stimulus wouldn’t pay for itself, but it would pay for part of itself.

• Second, if the investment is productive, it will expand the economy’s productive capacity in the long run.

This is obviously true for physical infrastructure and R&D, but there is also strong evidence that safety-net programmes for children make them healthier, more productive adults, which also helps offset their direct fiscal cost (Hoynes and Whitmore Schanzenbach 2018).

• Finally, there’s fairly strong evidence of hysteresis — temporary downturns permanently or semi-permanently depress future output (Fatás and Summers 2015).

Again, by avoiding these effects a sustained fiscal stimulus would partially pay for itself.

Put these things together and they probably outweigh any fiscal effect due to stimulus raising interest rates.

And here’s the thing: because a debt crisis doesn’t seem at all imminent, there will be plenty of time to reconsider if the arithmetic of infrastructure spending doesn’t turn out as favourable as I expect it will. If secular stagnation looks like less of a problem at some future date — say, during Alexandria Ocasio-Cortez’s second term in the White House — we can rethink permanent stimulus then.

Lessons from Japan

Some readers may have noticed that what I’m proposing — a sustained programme of deficit-financed public investment, through good times and bad — sounds quite a lot like Japan’s policies since the mid-1990s. What can we learn from Japan’s experience?

Let’s note at the outset that Japan’s debt dynamics are much less favourable than those likely to prevail in the US, for two reasons.

•First, Japan allowed itself to slide into deflation, and has yet to convincingly exit.

•Second, Japan’s potential growth is low due to extraordinarily unfavourable demography, with the working-age population rapidly declining.

As a result, Japan’s nominal GDP has barely increased over time, with an annual growth rate of only 0.4% since 1995. Meanwhile, interest rates have been constrained on the downside by the zero lower bound, so Japan has spent most of the past generation with r-g near zero, rather than the -.02 I’ve argued is reasonable for the US. This in turn means that Japan’s debt ratio has risen more rapidly than we should expect for America.

Even so, however, Japan still faces no hint of a debt crisis.

And Japan’s policy of permanent stimulus has surely contributed to the nation’s ability to maintain more or less full employment despite the weakness of private demand. Japan has at no point experienced the kind of mass unemployment and suffering that North America and Europe experienced for years after the 2008 crisis, and may be about to suffer again.

In other words, at this point Japan doesn’t look like a cautionary tale; it almost looks like a role model. I’ve suggested, only semi-facetiously, that Western economists like Ben Bernanke, Lars Svensson, and yours truly who were highly critical of Japanese policy circa 2000 make a formal apology. We’ve handled Japan-type problems far worse than they have.

Which brings me back to my original point: there’s a very good case for putting a sustained, productive program of stimulus in place as soon as possible, instead of scrambling to come up with short-term measures every time bad things happen. Because everything we see now says that bad times will be a very frequent occurrence.


References

Fatás, A and L Summers (2015), “The permanent effects of fiscal consolidations”, CEPR Discussion Paper 10902.

Hoynes, H W and D Whitmore Schanzenbach (2018), “Safety net investments in children”, Brooking Papers on Economic Activity, Spring.

Blanchard, O (2019), “Public Debt and Low Interest Rates”, American Economic Review 109(4): 1197-1229.

Summers, L (2013), Speech at the IMF Economic Forum, 8 November.