Olivier Blanchard’s Presidential Address to the American Economics Association a couple weeks ago confirms that policy-related academics have converged around the view that the US probably still has ample fiscal capacity. This perspective seems correct, although perhaps a bit slow to have been adopted by conventional macro.
The truth of that perspective, if I am correct in calling it that, would seem to have two practical implications. First, neither the bond market nor actors in the so-called real economy seem likely to freak out over fiscal sustainability at any horizon relevant to readers of this note. I doubt many readers will be much impressed by that point, which is probably obvious.
Second, the US has ample flexibility to deal with the next economic recession by delivering a fiscal stimulus. The intended consequences of such a stimulus would probably be achieved, while the unintended consequences would probably be quite limited, just like last time, although too briefly because the stimulus was withdrawn prematurely.
However, this does not mean that the US can rely on fiscal stimulus during the next downturn, for the simple reason that US policy makers are not inclined to act in the collective interest of the US. They are motivated by other concerns. As Ken Rogoff notes colorfully in a recent piece to Project Syndicate, relying on the contrary view would be “stupefyingly naïve.” Perhaps he overstates his case slightly.
The case for optimism around the next recession is that there is a good shot that it will arrive before major real-side imbalances have developed in the US economy, which means in turn that correcting those imbalances may not take long. Moreover, one of the key lessons from the Global Financial Crisis is that even a return to the lower bound on rates would not likely generate a deflationary spiral. It would more likely slow than abort recovery, setting up another unexciting low vol macro environment. =
At least that would be the effect taken in isolation. It is just that policy seems more likely to be an additional threat than itself a cause for optimism. Fiscal policy makers will have the opportunity to act helpfully in the next recession but we cannot rely on them taking it.