Martin Wolf John Taylor Niall Ferguson Paul Krugman

Is the US (and a number of other high-income countries) on the road to fiscal Armageddon?
Are recent jumps in government bond rates proof that investors are worried about fiscal prospects?
Martin Wolf, Financial Times June 2 2009

My answers to these questions are: No and No. This does not mean there is no reason for worry.
It is rather that there are powerful arguments against fiscal retrenchment right now and strong reasons for welcoming recent moves in the bond markets.

The latter, in turn, was a comment on a debate with, among others, the New York Times columnist and Nobel laureate Paul Krugman at the end of April.

On one point all serious analysts agree: public debt cannot rise, relative to gross domestic product, without limit. To embark on fiscal stimulus in the short run, one must be credible in the long run. So what is the disagreement?

The jump in bond rates is a desirable normalisation after a panic. Investors rushed into the dollar and government bonds. Now they are rushing out again.

What has happened is a sudden return to normality:
after some turmoil, the yield on conventional US government bonds closed at 3.5 per cent last week,
while the yield on Tips fell to 1.9 per cent.
So expected inflation went to a level in keeping with Federal Reserve objectives, at close to 1.6 per cent.

The most recent yield on Tips is below 2 per cent, while that on UK index-linked securities is close to 1 per cent.

Economists who believe in “Ricardian equivalence” argue fiscal policy is ineffective, because households will offset any government dis-saving with their own higher savings.

"Several observers have, therefore, recently questioned the traditional Keynesian view that automatic changes in the government budget deficit always function as a macroeconomic stabilizer. Reference is then made not only to the hypothesis of "Ricardian equivalence" according to which private saving would increase by as much as government saving has decreased... A recent more radical "revisionist" view is that galloping government debt may, in fact, have restrictive effects on the national economy.
The Swedish Experiment by Assar Lindbeck SNS Förlag 1997

A deep recession proves there is a huge rise in excess desired savings at full employment, as Prof Krugman argues. At present, therefore, fiscal deficits are not crowding the private sector out.
They are crowding it in, instead, by supporting demand, which sustains jobs and profits.

People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed.
If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered.
If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation.

Did inflation targeting fail?
Central banks have mostly escaped blame for the crisis.
How can it have gone so wrong? Also about The Taylor Rule
Martin Wolf, Financial Times, May 5 2009

Last week, the Financial Times carried two columns arguing that the US fiscal path was unsustainable, one by Stanford University’s John Taylor and the other by the Harvard historian Niall Ferguson

Last week, the Financial Times carried two columns arguing that the US fiscal path was unsustainable,
one by Stanford University’s John Taylor and the other by the Harvard historian Niall Ferguson