Christina Romer on the deficit and the economy

Christina Romer, chair of the Council of Economic Advisers, is also a scholar of the depression, and has taken away many of the same lessons Paul Krugman has. It’s a comforting sign that she recognizes the importance of continued federal spending right now, as well as the importance of reducing the deficit in the long term. She discusses all of that in a guest article for The Economist.

Here’s Romer on the need for continued spending. In fact, she warns that we might even need to increase spending if the private market doesn’t pick up the slack:

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently. If the government withdraws support too early, a return to economic decline or even panic could follow. In this regard, not only should we not prematurely stop Recovery Act spending, we need to plan carefully for its expiration. According to the Congressional Budget Office, the Recovery Act will provide nearly $400 billion of stimulus in the 2010 fiscal year, but just over $130 billion in 2011. This implies a fiscal contraction of about 2% of GDP. If all goes well, private demand will have increased enough by then to fill the gap. If that is not the case, broad policy support may need to be sustained somewhat longer.

And then on our long-term fiscal health, she writes about the need to gently and gradually reduce the deficit:

Now is also the time to think about our long-run fiscal situation. Despite the large budget deficit President Obama inherited, dealing with the current crisis required increasing the deficit substantially. To switch to austerity in the immediate future would surely set back recovery and risk a 1937-like recession-within-a-recession. But many are legitimately concerned about the longer-term budget situation. That is why the president has laid out a plan to shrink the deficit he inherited by half and has repeatedly emphasised the need to reduce the long-term deficit and put the debt-to-GDP ratio on a declining trajectory. In this regard, health-care reform presents a golden opportunity. The fundamental source of long-run deficits is rising health-care expenditures. By coupling the expansion of coverage with reforms that significantly slow the growth of health-care costs, we can dramatically improve the long-run fiscal situation without tightening prematurely.

The key here is thinking about the long term. We need to have a much longer outlook than American politics generally encourages. Yes, the Obama administration is running a large deficit — that will probably continue for another year or two. It’s not as if the administration is unaware of them and the danger they can pose. They are choosing heavy spending now for two reasons: to jumpstart the economy, and to institute reforms that will reduce the deficit for decades to come.

In the long run, the Obama administration’s policies are going to do a lot for our fiscal health. But they’ll need to have the political courage and the far-sightedness to stay the course, despite the public’s clamor to reduce the deficit prematurely. We will certainly need to solve the deficit problem — it’s just not time yet.