The Long Run vs. the Short Run

In a New York Times column on May 3, 2013, “Not Enough Inflation”, Paul Krugman writes that since we are now in a liquidity trap, where business is sitting on hoards of cash, what we need is more inflation.  A higher rate of inflation would encourage more borrowing and spending and make it easier to pay down debt.  Inflation is low because of the economy’s persistent weakness which prevents workers from bargaining for wage increases and forces business to hold down price increases.  He goes on to say that what we also need right now is “more stimulus, monetary and fiscal, to reduce unemployment” and that “the response from people who consider themselves wise is always that we should focus on the long run, not on short-run fixes”.  I think that Mr. Krugman has overstated his case as he so often does.
On May 4 the NYT “Off the Charts” columnist Floyd Norris shows that “Business Investment Rebounds Even as Recovery Drags”.  He looks at data for our four most recent recessions which shows that while consumer spending is growing slowly in our current recovery, and government spending (federal, state and local) is way down, business investment has been quite strong.  This is especially significant because the Stanford economist, John Taylor, has pointed out the amazingly strong inverse correlation between business investment and the unemployment rate.  (See also his more recent blog on February 4, 2013.)  This is a strong indication that the unemployment rate will continue to drop and perhaps even more quickly in coming months.
In summary: business investment in growing robustly, consumer spending is growing steadily, and quantitative easing (monetary policy) is just about maxed out.  Government spending is down but this is primarily because state and local governments have to balance their budgets.  So there is really only one policy lever left to further stimulate the economy, i.e. federal spending.
However this is where the long run matters at least as much as the short run.  With the national (public) debt currently at 76% of GDP and growing, it is simply too risky to let it go much higher.  In fact it is only prudent to begin reducing it as soon as possible.  Absent an unforeseen national emergency this must be our first priority.

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