"We have learned some things from comparable experiences of the 1930s' Great Depression, perhaps enough to reduce the severity of the current contraction. But we have made no progress toward putting limits on political leaders, who act out their natural proclivities without any basic understanding of what makes capitalism work."In particular, the authors, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run.
To some extent I agree with their analysis. I agree it was a terrible mistake to have
- Fiscal expansion and higher government borrowing during the Bush years of 2001-06. These years of economic growth should have been a time to reduce government debt, not cut tax and increase the deficit.
- Reckless Monetary expansion in 2001-07 encouraging a boom in house prices and stock market which led to subsequent bust and credit crunch which caused the most devastating recession since the 1930s.
If excessive government indebtedness is a major source of the problem, why increase the government debt? Why encourage households to go yet further into debt?If we learnt anything from the Great Depression, it was the necessity for the government to offset the rapid rise in private sector spending. (see: Principles of borrowing to see how the rise in government borrowing has offset the rise in private sector saving)
The great mistakes of the Great Depression were:
- Allowing so many banks to collapse
- Pursuing deflationary fiscal policy. Trying to balance the budget through higher taxes and lower spending. This mistake occurred at the beginning of the Great Depression and also in 1937, where a tightening of fiscal policy pushed the US back into a second recession.
It is not that we are trying to encourage more private sector debt. We are trying to prevent a too rapid fall in consumer spending which would cause an even larger rise in unemployment. The deficit spending is cyclical. Boosting growth is one of the best ways to increase tax revenues. When the economy is strong enough, the fiscal expansion can be reversed.
True, the burden of debt, is a problem. With an ageing population and increased health costs it will provide a challenge over medium and longer term. But, high government debt is not necessarily as crippling as some would like to exaggerate.
After the war, US debt was over 125% of GDP. Even by 1950, National debt was over 80%, this proved no barrier to the US having two decades of very strong economic growth. (Paul Krugman explains more at - A couple of notes on 40s and 50s)