The wrong time to reverse course

THE WRONG TIME TO REVERSE COURSE…. The still-weak economy no longer appears to be standing on the edge of a cliff. A few too many on the right interpret this evidence of the need to reverse course on the recovery efforts.

Congressional Republicans, for example, want to stop spending stimulus funds altogether. Pundits are warning of inflation, and the effect of deficits on interest rates. Reporters are running lengthy pieces about the Obama administration and the need to curtail government spending.

Paul Krugman thinks it’s time for a reality check.

First of all, while stock markets have been celebrating the economy’s “green shoots,” the fact is that unemployment is very high and still rising. That is, we’re not even experiencing the kind of growth that led to the big mistakes of 1937 and 1997. It’s way too soon to declare victory.

What about the claim that the Fed is risking inflation? It isn’t. Mr. Laffer seems panicked by a rapid rise in the monetary base, the sum of currency in circulation and the reserves of banks. But a rising monetary base isn’t inflationary when you’re in a liquidity trap. America’s monetary base doubled between 1929 and 1939; prices fell 19 percent. Japan’s monetary base rose 85 percent between 1997 and 2003; deflation continued apace.

Well then, what about all that government borrowing? All it’s doing is offsetting a plunge in private borrowing — total borrowing is down, not up. Indeed, if the government weren’t running a big deficit right now, the economy would probably be well on its way to a full-fledged depression.

Oh, and investors’ growing confidence that we’ll manage to avoid a full-fledged depression — not the pressure of government borrowing — explains the recent rise in long-term interest rates. These rates, by the way, are still low by historical standards. They’re just not as low as they were at the peak of the panic, earlier this year.

To sum up: A few months ago the U.S. economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual. Those demands should be ignored.

They haven’t been ignored under similar circumstances in the past. In 1937, as the U.S. economy started to emerge from the Great Depression, FDR listened to Republicans and began to take deficit reduction seriously — prompting another economic downturn. In the 1990s, Japan’s economy started to recover, so policy makers turned their attention to spending cuts and deficit reduction — prompting another economic downturn.

Last week, Treasury Secretary Timothy Geithner told G8 finance ministers that it’s “too early” to “shift toward policy restraint,” adding that deficit concerns must be set aside for now.

He’s right.