08 June 2011

Krugman and Eggertsson on why more spending may make sense even when debt is high

The key message to take home:
"One thing that is especially clear from the analysis is the likelihood that policy discussion in the aftermath of a deleveraging shock will be even more confused than usual, at least viewed through the lens of the model. Why? Because the shock pushes us into a world of topsy-turvy, in which saving is a vice, increased productivity can reduce output, and flexible wages increase unemployment. However, expansionary fiscal policy should be effective, in part because the macroeconomic effects of a deleveraging shock are inherently temporary, so the fiscal response need be only temporary as well. And the model suggests that a temporary rise in government spending not only won’t crowd out private spending, it will lead to increased spending on the part of liquidity-constrained debtors." (page 23 - Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach)

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