Tuesday, October 6, 2009

Stimulus Questions

Nobel Prize-winning economist Paul Krugman recently opened up his blog for questions from the readers. He answered a few and the entire Q&A is online and it's educational for those who have questions about the stimulus, the recession, health care, etc. He's a smart man, and his answers are obviously well-thought out and intelligent. Go read what he wrote.
But, unfortunately for me, he didn't answer the question I asked, so I asked my question again, but this time I asked it in the comments section of Brad DeLong's blog (Professor DeLong is an equally intelligent economist) but alas, no answer, yet.
So I suppose I'll write my question(s) here and see if anybody stumbles across it in the future and can shed light on some of these issues for me.
Firstly, regarding the stimulus: Government spending in WWII is what pulled the United States out of the Great Depression. It proved Keynes correct and validated most (if not all) of his theories that fiscal policy could fill the output gap between real GDP and potential GDP during a recession (or depression). However, the world looks very different today than it did in the 1940s and I'm not concerned about the short-run equilibrium of AS-AD or of the effects of the stimulus on real GDP. My questions concern the Long Run Aggregate Supply Curve (Potential GDP).
The "stimulus" of WWII set the stage for long-run economic prosperity in the United States, but the postwar boom here was also fueled by interest payments the United States received from England and Germany. In fact, there was interest earned on interest in some cases, as we loaned money to Germany who had to pay war reparations to England who was in debt to the United States. In addition to these interest payments from other countries, the debt that funded WWII's spending was largely internal debt--meaning the United States went into debt to its own citizens for the most part. But now, however, there is a much larger percentage of US debt owned by sovereign funds (some estimates claim sovereign purchases of US debt has reached nearly 40%).
In the end, my questions are: What does this mean for the long-term recovery? Will potential GDP be lower because a large portion of government debt is given to foreign countries? Does this lower "I" or "G" or neither? Does it matter? Will the new, lower LRAS slow immigration and investment in the US and re-direct capital and resources to growing economies? Will the US, after this collapse, emerge from the crisis much the same way England did from WWII--meaning a sort of economic decline that lasts for a decade or more, accompanied by eventual replacement as the world's economic superpower, while foreign countries like China and India rise? Did Christie Romer include the sovereign purchases of our debt and the interest-on-interest we earned after WWII in her multiplier calculations for the ARRA? Is there an automatic offset to the sovereign funds and interest-on-interest by the TYPE of spending in the ARRA?
What I mean by that is: Keynes proposed that stimulus spending should be spent on useful things if possible, but completely wasteful things if necessary. He proposed burying money in mineshafts so that workers would be hired to dig it out. And WWII's stimulus spending was really no different than wasteful spending because in the end, as Bruce Bartlett so aptly put it:
"WWII proved to be an effective stimulus that, economically speaking, consisted of 100% waste. If the war hadn't broken out, the US could have enjoyed the same economic benefit of the stimulus by building all the tanks, planes and bombs and simply dumping them into the ocean."
So, will there be natural offsets in the ARRA on the "interest and sovereign fund" issues because of economically useful stimulus spending? And, again, how much of this was calculated by the ARRA's creators? And, finally, as I asked Dr. DeLong... what is the air-speed velocity of an unladen swallow?

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