Dr. DeLong has a post today that covers the four tools available to turn around a depressing economy:
- Inflation - Inflate your way out. This is really bad, but preferable to another great depression. We will do this if we have to, but it’s not that bad yet.
- Monetary Policy – The central bank buys government bonds to entice business to invest in production. This is the weapon of choice, but we’ve already exhausted its possibilities.
- Credit Policy – The government tries new policies designed to loosen lending and get people investing in otherwise risky projects. We’re trying this a little bit.
- Fiscal Policy – The government borrows and spends, directly stimulating the economy.
From Dr. Delong:
This brings us to the fourth tool: fiscal policy. Have the government borrow and spend, thereby pulling people out of unemployment and pushing up capacity utilisation to normal levels. There are drawbacks: the subsequent dead-weight loss of financing all the extra government debt that has been incurred, and the fear that too rapid a run-up in debt may discourage private investors from building physical assets, which form the tax base for future governments that will have to amortise the extra debt.
But when you have only two tools left, neither of which is perfect for the job – credit policy and fiscal policy – the rational thing is to try both, at the same time. That is what the Obama administration in the United States and other governments are attempting to do right now.
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