Enough with the economic recovery: It's time to pay up

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By Steven Pearlstein
Friday, June 11, 2010

Just about now, you may be a bit confused about the economy.

Some economists and policymakers look at growth in output and see the beginnings of a sustainable recovery. Others note that most of that recent growth reflects a return to high spending and low savings, which is most definitely unsustainable.

Some look at core inflation rates of less than 1 percent in major industrialized countries and worry about deflation. Others look at soaring government deficits and central banks' ballooning balance sheets and warn of inflation just over the horizon.

Some insist there is an urgent need for another shot of Keynesian fiscal stimulus -- government borrowing and spending to create jobs -- which they assure will largely pay for itself with the extra tax revenue it will generate. Others warn that any more debt will cause markets to raise interest rates so high that it will eat up most of the proceeds from new borrowing.

Some forecasters expect that fast-growing developing countries such as China and Brazil will power the global recovery and spur a rise in U.S. exports. Others warn that fiscal austerity and slow growth in Europe threaten the recovery.

Even the people who are supposed to really understand this stuff can't come to consensus on where things are headed and what we should do next. And I have a hunch why that is: At this point, there are no good solutions -- only a choice among painful and distasteful ones.

The controlling reality is that the global economic system is rebalancing itself after years in which the United States was not only allowed but encouraged to live beyond its means, consuming more than it produced and investing more than it saved. Now the bill for that is finally coming due -- all the clever and seemingly painless ways for postponing that day of reckoning have pretty much been played out. The only question now is what form that payment is going to take. Will it be an extended period of subpar growth and high unemployment, inflation that erodes the purchasing power of our income and the value of our assets, a deflationary spiral that grinds down wages and salaries and increases our debt burden -- or, as I suspect, some combination of all three?

One reason for all the disagreement is that any decisions about the form of payment will have a big effect on how the burden is distributed -- between debtors and creditors, importers and exporters, those with lots of wealth and those with little, workers with market power and those without.

What has been disappointing is that those in the position of economic leadership have not been more candid about the reality of this predicament and the limits of what government can or should do about it.

Ben Bernanke and his colleagues at the Federal Reserve, for example, have refused to acknowledge that by keeping interest rates at zero "for the foreseeable future," they have begun to generate new bubbles in financial assets and overheated the economies of developing countries, where much of the money is going. These are many of the same folks, after all, who once claimed they couldn't see the credit and real estate bubble developing right under their noses -- and, once those bubbles burst, rejected criticism that overly loose monetary policy might have been a cause.

One economist whose warnings the Fed failed to heed back then was Raghuram Rajan, the former chief economist of the International Monetary Fund who in 2006 delivered a now-famous paper on the subject at the Fed's annual retreat at Jackson Hole, Wyo. Now Raghuram is sounding the alarm again, warning that while a weak U.S. economy still requires the Fed to hold interest rates relatively low, keeping them at zero is both dangerous and unnecessary, generating little extra output in the United States while creating hot money flows abroad.

Equally disappointing in recent months has been the performance of the Obama White House, where it seems the political advisers have taken control of economic policy. Rather than allowing Republicans and Blue Dogs to frame the economic debate around the urgency of deficit reduction, this was the time for the president to focus the country on rebuilding the foundations for long-term economic growth. At this point, neither the politics nor the economics support the idea of spending large sums, directly or through tax breaks, just to shave a percentage point off this year's unemployment rate. But with plenty of slack in the economy and interest rates at historic lows, this is the ideal time to borrow and invest heavily in public infrastructure that has been badly neglected over the past 30 years.

I'm referring not only to roads and bridges but also to airports and air traffic control systems, urban transit, high-speed rail, schools and university facilities, national laboratories, national parks, "smart" electric grids, broadband networks, green generating plants, and health information networks. Properly chosen, these projects can have huge long-run economic payoffs while tangibly improving the lives of all Americans. They're the kind of government spending today's voters can get excited about while also leaving a valuable legacy for future generations -- along with the debt that was used to finance them. And if they wind up creating some jobs at a time when millions of people are unemployed, so much the better.

Having stabilized the economy and the financial markets, it is neither possible nor desirable for the government to try to delay any further the painful adjustments needed to put the global economy back into balance. It's time to settle up and get on with the more exciting challenge of shaping our long-term economic future.


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