Reagan Supply Sider on The New Deal: “Deficits were too small, not too large.”

Forget “centrism.” How about “sensible-ism”?

Bruce Bartlett displays it in spades in his new Forbes article. Just as he did–to some extent–in his book Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy.

Bartlett also wrote Reaganomics: Supply-Side Economics in Action–which is decidedly admiring of that belief system–so you know where he’s coming from.

His article limns an economic history of the Depression, the New Deal, WWII spending, and the ensuing Great Prosperity that’s quite similar to mine. (i.e. “net fiscal stimulus ’32-’39 was actually quite tepid.”)

…John Maynard Keynes and other economists argued that in such circumstances, which economists call a liquidity trap, the federal government had to compensate for the falloff in private spending in the economy by increasing government spending. This was necessary to get the economy moving from a stationary position, at which point money would begin to circulate, Fed policy would again be effective, and prices would start to rise…

…there were those who nevertheless viewed any rise in prices as the first step on the road to German-style hyperinflation. Insanely, they argued that the government had no business compensating for any amount of deflation…

The critics were also totally opposed to deficit spending. As with Republicans today, they said that federal borrowing would simply draw funds out of productive uses in the private sector to be squandered on make-work government jobs, pork barrel projects of dubious value and welfare programs that would sap the dynamism of the American economy.

Apparently, it didn’t occur to these critics that the existence of vast unemployment, closed factories, abandoned farms and extremely low interest rates meant that much of the private sector’s resources were simply idle. Borrowing them by running deficits didn’t reduce private output because there were no alternative uses available.

Furthermore, an expansive fiscal policy was essential to recovery because without it monetary policy was impotent…

I’ve highlighted those passages because Bartlett highlights this point in responding to commenters on his article:

One of the points I have tried to emphasize, but I don’t think is yet clear, is the essential connection between monetary and fiscal policy.

I don’t believe, as many Keynesians do, that fiscal policy is inherently stimulative. In this sense, Barro is right. But he forgets that there are times, like now, when we are in a liquidity trap, when fiscal stimulus is essential to make monetary policy effective. The monetary policy is what provides the real stimulus, but it needs fiscal policy to be operational.

Fiscal policy can make monetary policy work. This viewpoint isn’t getting the discussion it deserves–at least not in those clear terms.

Even the most wild-eyed Keynesians will stipulate that monetary policy (Fed funds rate, money supply) has by far the greatest leverage–it sometimes seems magical. When Volcker eased in the early 80s, the economy started surging back within months. I heard Krugman make exactly that point in a lecture last week.

Supply-side monetarists, on the other hand (think: Tyler Cowen), make no concessions. They think fiscal stimulus–no matter how large–has no effect on anything except government debt. Bartlett is to be admired for bucking that blindered, faith-based intransigence.

Inflation in the early 80s was still high. That’s why Volcker’s move was so powerful, and its effects so immediate. Today, with Fed funds at zero and inflation threatening to go negative, monetary moves are like Superman on kryptonite.

Fiscal stimulus can give the Fed back its mojo. Unfortunately, fiscal policy doesn’t have the leverage that monetary policy does. (Whatever reasonable multiplier you choose.) That–sad to say–is why you need lots of it.