Why won't we let the market be irrational in our favor?
After listening to Alan Greenspan's presentation Friday, I think it's safe to place him in the camp that would like to see a quick move toward a more austere budget. When Walter Isaacson asked him whether stimulus or deficit reduction should come first, he said "the question is not all that difficult once you recognize that there is far greater momentum in the budget deficit and in spending than in the official figures." In other words, it's time to move on deficits.
The problem, as he admitted, is that "the fiscal strain" that would normally alert the political system to a deficit problem and increase pressure for action is totally absent. "Fiscal strain shows up either as crowding out, inflation or higher interest rates," he said. "There is some crowding out that we can measure, but not much. There's no inflation. And interest rates are, if anything, falling."
Greenspan took that as evidence that the market is being irrational about our debt, largely because it's so afraid of European debt. I don't totally disagree. But when investors spot an irrational market -- particularly an irrational market in their favor -- they exploit it. Greenspan and others seem to think we need to correct it.
Here's an old economics joke: Two economists are walking down the street. One says: "Hey, there's a dollar bill on the floor." The other says: "Impossible. If it were real, someone would have picked it up by now." The austerity take is even weirder: They counsel that we should pick it up, and then hand it over to the police to track down whoever dropped it and make sure they don't do so in the future. Oh, and we should do all this despite a warrant out for our arrest.
If we've got a limited period in which our borrowing costs are low because the rest of the world is in terrible shape, then it would make sense to use this period to frontload the investments we need to make to get short- and long-term economic growth on track. In the short-term, that means things like unemployment insurance and state and local aid. In the long-term, that means investments in infrastructure and education and research and development. Instead, at a moment of record-low borrowing costs, we're letting cash-strapped California gut the UC system. That's a one-two punch: We lose jobs now, and we lose educated workers later.
As an economic strategy, it's baffling. We have an opportunity here. We should use it. And we should combine it with the sort of long-term policies that will reassure the market about our future trajectory. But refusing to let the market be irrational in our favor is, at the end of the day, to be irrational ourselves.
Update: I ran into Greenspan later, and we talked a bit more about this. He explained that he doesn't think the market is irrational. Rather, he believes that the rational short-term behavior, which includes very low rates on US debt, will eventually give way to rational long-term behavior, and we'd be wise to address the problem rather than risk the panic of the market's correction.
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