Brad DeLong: Rethinking Finance: New Perspectives on the Crisis ...

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FEATURED:

The Basic Arithmetic of Self-Financing Fiscal Policy:

Fiscal policy in a depressed economy is self-financing as long as:

where r is the real Treasury borrowing rate, g is the growth rate, which is 2.5%; ? is the fraction of GDP that shows up as increased tax revenues, 1/3; ? is the (debatable) standard Keynesian multiplier when monetary policy is at the zero lower bound; and ? is the (largely unknown) hysteresis shadow a downturn casts on future potential output?.

[I]t is possible to be highly confident that the depressed-economy standard Keynesian multiplier when monetary policy is at the zero lower bound ? is greater than 1.0, and substantially confident that the hysteresis shadow ? cast by a long, deep depression is greater than 0.05.

The arithmetic means that over the past four years fiscal policy has been self-financing, and would be self-financing unless the real Treasury borrowing rate is rapidly going to become greater than 5%--unless the nominal Treasury rate is rapidly going to burst through 7% heading upwards. It has simply never been at such levels, save for a short span of years during and immediately after the Volcker disinflation.

Thus, even if you think that the United States is on the edge of some kind of fiscal crisis and may be about to transit from a low interest rate "confidence in government" to a high interest rate "panic" equilibrium, increases in debt-service loads relative to GDP from fiscal austerity are more likely to shock the system into the bad equilibrium than are policies of fiscal expansion. Fiscal expansion over the past four years would--exceptionally and extraordinarily--have, for once, by the arithmetic, paid for themselves.

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