Advancing a Free Society

Dynamic Dr. Krugman

Monday, June 14, 2010

In his column today Dr. Paul Krugman argues that the deficit impact of a large ($1 trillion) stimulus would be mitigated by the effects of higher GDP growth:

Consider the long-run budget implications for the United States of spending $1 trillion on stimulus at a time when the economy is suffering from severe unemployment.

That sounds like a lot of money. But the US Treasury can currently issue long-term inflation-protected securities at an interest rate of 1.75%. So the long-term cost of servicing an extra trillion dollars of borrowing is $17.5 billion, or around 0.13 percent of GDP.

And bear in mind that additional stimulus would lead to at least a somewhat stronger economy, and hence higher revenues. Almost surely, the true budget cost of $1 trillion in stimulus would be less than one-tenth of one percent of GDP – not much cost to pay for generating jobs when they’re badly needed and avoiding disastrous cuts in government services.

Dr. Krugman focuses only on the long-term debt service costs of a large new stimulus.  This assumes we keep the full trillion dollar cost of his hypothetical stimulus as public debt forever, and he argues the “true budget cost” is just the added burden of interest payments.  I think looking at only the interest costs is an incomplete way to measure the true budget cost of a policy change, but today I want to focus on the bolded sentences and walk through Dr. Krugman’s logic.

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