This articleby Messers Jordà, Schularick, and Taylor of the San Francisco Fed is recommended reading according to Mark Thoma. God knows why. It’s drivel.
In their second paragraph, they set out the hoary old “fiscal space” idea.
That is, in their second paragraph they claim, “..it appears that keeping public debt low is a good insurance policy in case a financial crisis occurs and the financial sector needs to be rescued. A low level of debt coming into a crisis also gives the public sector more latitude to make up for the fall in demand.”
Now that’s all very much in accordance with the conventional twaddle/wisdom. But’s it’s rather spoiled by the preceding sentence which says “..high levels of public debt seldom trigger financial crises in advanced economies”.
Well if “high levels of public debt” aren’t a problem, that contradicts the idea that it’s desirable to maintain a low level of debt in order to deal with crises when they occur! Doh!
The next blunder comes in the third paragraph where they say “public debt has reached levels last seen following the two world wars”. Er…. no. At least as far as the UK goes, public debt hasn’t reached anywhere near those post war levels.
Moreover, the fact that those elevated debt levels didn’t pose any big problems supports the authors’ above mentioned claim that “..high levels of public debt seldom trigger financial crises..”.
The big “conundrum”.
The Fed authors’ next blunder is their claim that “The conundrum facing policymakers is this: Implement too much austerity and you risk choking off the nascent recovery, possibly delaying desired fiscal rebalancing. But, if austerity is delayed, bond markets may impose an even harsher correction by demanding higher interest rates on government debt.”
Well first, (and I hate to labour the point) but the authors themselves pointed out that “..high levels of public debt seldom trigger financial crises”.
Second, even if “bond markets” do “demand higher interest rates” there is a phenomenally simple solution: 1, print money, 2, pay off creditors, and 3, to the extent that the latter policy is too inflationary, raise taxes to reduce the excess demand.
In fact several countries have been doing exactly the latter and on an unprecedented scale recently: it’s called “quantitative easing”. Possibly those Fed authors haven’t heard of QE.