A comment on Alan Greenspan's analysis of the slow recovery in the FT

Alan Greenspan has written an interesting analysis of the slow recovery for the FT. ''Fear undermines Americas recovery." I commented on it and have reproduced the comment below. see the FT Oct.7, 2010.

Harold Chorney | October 7 3:16am | Permalink

Alan Greenspan is focusing on a critical issue that has dogged the debate over stimulus ever since Keynes, Kahn,Kalecki and their circle at Cambridge aided by Lauchlin Currie,(a Canadian trained at Harvard who advised Roosevelt )Marriner Eccles, the head of the Fed, and Alvin Hansen the leading Harvard economist who was an expert on secular stagnation in America made the case for debt financed capital investment in infrastructure and the stimulus of consumption through fiscal measures as the antidote to slumps. The Europeans preferred capital works, the North Americans leaned more towards stimulating consumption. But whatever the preference the policy always implied a short term rise in deficit spending. The Treasury view which in some respects Greenspan is advocating, albeit in a reformulation that welcomes a temporary rise in deficit spending to cope with the financial crash and the initial rounds of shocks to the economy, argued as Greenspan appears to, that increasing the public sector deficit would crowd out private investment that would otherwise be forthcoming. But, of course, as Keynes, James Meade, Abba Lerner and later Keynesians, like James Tobin have pointed out this need not be so.

In fact, the very opposite is more likely to occur as the recovery develops. The government loan financed expenditures which draw on otherwise idle savings stimulate the recovery so that private funds waiting on the sidelines because of fear of loss are crowded back into the economy as the recovery proceeds. To deal with the problem of increasing fear and the demand for loanable funds causing risk premiums to rise and interest rate to increase
we now have additional policy tools available in the form of quantitative easing.

The legitimate question to be resolved in the coming months is whether the reluctance to invest will continue as the economy recovers or will private funds begin to accelerate their reinvestment in profit seeking capital investments ? If they do not the question of who is right cannot be resolved simply by arguing that there is a correlation between investment not occurring and the deficit not shrinking fast enough or for that matter the new complex banking regulation which if nothing else were simply unavoidable after the debacle of 2008.

We still have other plausible possible explanations involving the size of the stimulus being too small and too slowly applied to yield a better outcome. This was true in the mid thirties and it is likely to be true in 2010. Cutting deficits through the premature application of restraint would be a bad idea.

Mr. Greenspan must know that the cuts have both real and expectational immediate negative impact upon aggregate demand which would reduce and probably overwhelm any positive good that they might have with respect to private investors' expectations.