Memo to policymakers: Listen to Paul Krugman

Paul Krugman has been right about nearly everything concerning the economic crisis. Therefore, one would hope that sensible policy makers would pay careful attention to Krugman’s analysis. Krugman, in a recent op-ed, says the government can’t relax its plans to stimulate the economy. While things are getting better now, they could easily take another turn for the worst, just like they’ve done before:

The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment.

Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.

The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession.

And here we go again.

Krugman’s message is simple: We’re not out of the woods yet. The last two times we’ve been in a “liquidity trap,” as Krugman puts it, the economy has retrenched after a period of improvement. That means that, despite the political implications, Democrats should keep spending. Republicans are going to continue to paint Obama and the Democrats as fiscally irresponsible and big spenders, but the best thing Democrats can do is stay the course and make sure they actually fix the economy. If the economy has rebounded by November 2010, Democrats will be rewarded; they won’t get any points for caving to conservative pressure and pulling the economy back down.

Of course, there are now legitmate concerns about the deficit and inflation. They can’t be ignored, as these fears are starting to undermine any potential economic growth, but as Krugman says, the Obama administration must wait to deal with the deficit until the economy is well and truly growing again. There’s a very delicate balancing act here.

I think the administration’s approach so far has made a lot of sense, although admittedly I don’t know if this has been an intentional strategy or not. Obama has talked a lot about the deficit and put plans in place to reduce it, but has not yet seriously tried to cut spending. Both of these are good things. Obama needs to persuade investors that he is serious about curbing the deficit, and he needs to have a plan in place to do it. However, it’s not actually time to cut spending yet — just time to get ready.