The Paradox of Thrift and Monetary Policy

Via Max Sawicky, Austan Goolsbee on Why Deficits Still Matter:

White House officials have repudiated the Clinton administration’s view that fiscal responsibility lays the groundwork for sustained economic growth. Often identified with former Treasury Secretary Robert Rubin, this view held that by running massive deficits and borrowing heavily, the federal government drove up the cost of capital. By cutting the deficit, it could bring interest rates down and thereby stimulate new waves of private investment. The economic boom of the 1990s seemed to prove Rubinomics right. But Republicans have nonetheless rejected that approach. Glenn Hubbard, formerly President Bush’s top economic adviser, said in a December 2002 speech: “One can hope that the discussion will move away from the current fixation with linking budget deficits with interest rates.” When pressed on the point, he responded: “That’s Rubinomics, and we think it’s completely wrong.” More recently, in an editorial marking the 25th anniversary of Ronald Reagan’s inauguration, the conservative Wall Street Journal opined that Rubinomics was a failure, and argued that history had vindicated the supply-side line that tax cuts are the most important policy that government can undertake.

We should keep in mind that Professor Glenn Hubbard is an advocate of more national savings so his December 2002 comment must be excused as him either being under Karl Rove’s watchful eye or drunk on the Kool Aid. But Max is referring to Goolsbee’s call for long-term fiscal restraint as “Deficit Dementia”. Max objects to blindly moving towards fiscal restraint on two grounds. His premise that not all deficit reduction ideas are the same is something I would absolutely agree with. But I’m not so sure about this:

The most important thing to note is the argument he throws over – the time-honored “crowding-out” thesis beloved of Econ 101 textbooks. The premise is that when the economy is at “full employment,” government borrowing raises interest rates (“supply and demand”) and discourages some margin of business investment. This was all the rage in the 80s and 90s among mainstream economists, especially those left-of- but not-far-from-center. The Brookings Institution was the temple of crowding-out economics.

I would tend to argue that as long as we can insure that we are near full employment, reductions in national savings will crowd-out either investment or net exports – if not both. But Max could point to Kash who is trotting out the Paradox of Thrift argument where attempting to save more just leads to recession. Our friend Mark Thoma echoes Kash’s concern. The Pro-Growth side of me has to say HUH?

Look – the premise of the Paradox of Thrift is that if we consume less, investment and net exports will not increase to take up the slack in aggregate demand. But doesn’t this presume that the Federal Reserve will feel compelled to keep interest rates high? After all – increases in investment combined with dollar devaluation – the latter encouraging more net exports – was what Rubinomics was all about. OK – Bush’s fiscal policy thinking is dominating by National Review nitwits who think less national savings and tight monetary policy is somehow pro-growth. But I seem to recall the Clinton years as experiencing significant growth even as we moved towards fiscal restraint. Then again – that took an understanding between the fiscal authorities and the Federal Reserve that we would have a macro-mix that was entirely the opposite of the mess we have today.

Update: In the comment section, one AB reader suggested that Robert Rubin preferred a strong dollar. It seems Dean Baker made the same argument. Perhaps, but I’d like to hear more from Dean on how policy promoted this over-valued dollar. Also K Harris wondered if Lord Keynes really bought into this Paradox of Thrift idea. I’m note sure but I thought Chapter 23 might be an interesting read as Lord Keynes reaches back to his predecessors – some of which did have early version of this paradox.

Update II: Via Brad DeLong, it appears that Chairman Ben is also calling for more national savings. I’m elated as he’ll be the one hopefully leading the easing up of monetary policy if the national savings schedule does shift up.