It would be wrong for the Obama administration and Congress to reduce the fiscal stimulus in 2009 or 2010, since there is no clear evidence of a sustained upturn. But it would be equally wrong to allow the national debt to double to 80 per cent of GDP a decade from now. Increasing taxes even more than proposed would weaken demand in the near term and hurt economic incentives in the long run. The fiscal deficit should therefore be reduced by curtailing the increases in social spending that the president advocated in his election campaign.
Mark Thoma tackles the when to impose fiscal restraint question with:
Here's (my interpretation of) Paul Krugman's argument about the source of recent movements in long-term interest rates: There are two reasons long-term rates might rise, first more worries about the debt and inflation in the future would drive rates up, and second the prospect of better economic conditions in the future would have the same effect, rates would go up. Suppose we receive bad news about the current state of the economy. That should cause expectations of lower output growth in the future, and hence lower tax revenues and higher spending on social programs than would exist with a stronger economy. So the bad news should cause an expectation of a larger deficit and more inflation worries, and that would drive long-term interest rates up (these worries would also make foreign central banks less likely to fund US borrowing which would reinforce the increase in long-term interest rates). But if it is future economic conditions that are driving the changes in long-term interest rates, bad news about the economy should drive rates down. Last week, we received bad news about the economy. If the debt/inflation/foreign lending story is correct, long-term rates should have gone up. If the state of the economy story is driving rates, rates should have fallen. What did long-term rates actually do? They fell.
Even if we are not currently witnessing crowding-out, we shall one day have to alter the current fiscal stimulus. But that does not mean we have to curtail social spending. We do have alternatives such as raising taxes or cutting defense spending. Feldstein may be a Republican, which appears to mean that he is less willing to say that high defense spending and low taxes also lead to long-run crowding-out. But it does – and I just wish conservative economists would occasionally admit this reality.