The Statement on the Other Side of This Paper Is True: Today's Unfortunate Economic Policy Dilemma

You probably have seen the same puzzler that I recall from years ago. Someone hands you a note paper on which are written the words, "The statement on the other side of this paper is true." You turn the paper over and find the words, "The statement on the other side of this paper is false."

I suspect that logicians have found some way around this mind-bender. On that, I must beg off. But there is an analog in the current economic policy debate. One side argues firmly that "We can't afford to stimulate the economy." The other counters with equal vigor that "We can't afford not to."

Unfortunately, both sides may be right.

We can only hope that there is a way between the horns of this dilemma. But there are no guarantees. There is a firm lesson only for the next time when -- if -- the nation is so lucky as to come to the entryway to this maze.

The case for economic stimulus right now is extremely strong. Where is the greater risk: on the upside, with faster than expected growth and accelerating inflation; or on the downside, with a second dip of recession and perhaps even chronic deflation? A poll of economists on that question would not be close. Economic indicators from employment to housing are flashing yellow signals.

Remedies are hard to come by. Conventional Federal Reserve policy already is fully wound out, with the federal funds rate as close to zero as possible. Further "quantitative easing" options, purchasing financial assets such as longer-term Treasury securities to reduce those longer interest rates, are at the ready. However, those measures are of uncertain efficacy. All else equal, few economists would argue against buying some insurance against the downside risk with a further jolt of fiscal stimulus.

But all else is not equal. The federal government's public debt already is at 60 percent of the GDP, its highest in more than half a century, and it is rising rapidly. Factor in the debt of state and local governments and the United States is in the company of other nations that are considered high risks of financial crisis, and into the admittedly vague danger zone identified by recent research. Elected policymakers have confronted the vital question of the treatment of the large expiring tax cuts, and they have procrastinated. All else equal, virtually every macro- or public finance economist would cry for Washington to get serious -- immediately -- about reducing the federal deficit.

When will all else get equal and save us from these conflicting crises?

Extreme positions in this policy debate are easy to find. Some assert that the nation cannot afford to extend the duration of unemployment insurance benefits for the long-term jobless, in the face of the worst job market in 30 years, and despite every piece of evidence that jobs are extraordinarily hard to come by in most parts of the country. On the other side is a campaign to argue that "deficits don't matter," so stimulus can be applied with abandon and without fear of a rising public debt, despite all the recent financial turmoil here and around the developed world.

The more nuanced position relies on timing. It calls for stimulus first, followed by fiscal restraint as the economy recovers. This follows the classical prescription for fiscal policy in any economic cycle: Encourage the economy into an upturn, but lift off the gas before resource use becomes too tight and inflation accelerates. Under normal circumstances, this is tricky enough. No one knows the future, and economists have long lamented that fiscal policy is almost always late -- both in applying stimulus, and then in removing it. But circumstances today are far from normal, with several economic indicators - including interest rates and the public debt -- either near their historical extremes or beyond. It is difficult to navigate when you sailed off the end of your chart days ago.

The only sensible path that we have is the nuanced, timed approach. We need greater confidence that the economy will avoid renewed recession so that monetary policy can begin to move off of its historical extremes. And we need an early commitment to deficit reduction, with its effect postponed until the economy is stronger, to buy time before the credit markets panic and raise interest rates -- over whatever objections the Federal Reserve might make.

But there is no guarantee that even the most carefully timed policymaking will not fail -- that both the "can't afford tos" and the "can't afford not tos" will be proved correct. The credit markets could panic under the weight of a mass of Treasury paper before the economy recovers. The economy could drop into renewed recession despite an attempt at stimulus, given financial dislocation abroad and the legacy of overbuilding of real estate at home, and that downturn itself could trigger a financial panic. We are in uncharted waters.

Only one thing is clear from our current conundrum -- and that is that we should never have allowed ourselves to get here in the first place. If our nation ever again finds itself at the policy crossroads that we reached at the turn of the millennium -- and I pray that it happens in my lifetime -- we should not again listen to those who preach fear of a future with too little public debt. Even Alan Greenspan -- whose green light for early and massive dissipation of budget surpluses in 2001 unfortunately short-circuited that debate -- seems to have realized the tragedy of that decision. The nation can find a way safely to use budget surpluses after paying down the public debt -- praying, again, that we are so fortunate as to have a second chance.

Joseph Minarik is Senior Vice President of the Committee for Economic Development (CED), a member of the Bipartisan Policy Center's Debt Reduction Task Force, and a contributing author of the recently released National Research Council report, "Choosing the Nation's Fiscal Future." Dr. Minarik also served as Associate Director for Economic Policy of the Office of Management and Budget in the Clinton Administration."

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