Spend or Not To Spend

The world's economic crisis has not gone yet. Many economies are still crippling and trying to find a new way to boost growth. The standard policy during economic crisis is to give stimulus and unemployment benefit. But now, the still-sluggish economy faces a new-arising crisis of swelling fiscal deficit which has claimed a victim, Greece. And Greek generous pension system has now been under fire for its contribution to the large deficit. (see Reference #1)

Large deficit debacle of Greece spooked many countries all across the world. Many countries from United Kingdom to Japan is now controlled by deficit hawks. Under the fiscal retrenchment action, the government budget will be shrunken.

Now the government have 2 alternatives of action: stop its stimulus, unemployment benefit and shift to parsimony or go on because of still-sluggish economy?

Apparently, noted economists have different answers.

The answer of Nobel Prize-winning economist, Paul Krugman: continue spending! The government should help the unemployment and continue the economic stimulus until the certain good economic condition and then save the money. In a nutshell, spent now, save later. But when is the perfect time to save? The right time is when the Federal Reserve has traction on economy, so it can reduce the interest rate to offset the rising of tax and spending cuts. Now the Feds can do nothing with its instrument because the interest rate is nearly zero. (see Reference #2)

In contrast, Harvard University Professor, Alberto Alesina has different prescription. To face the large deficit budget, the fiscal retrenchment is the right answer. The idea is the government's lower spending need lower tax and as the consequence it will lead the rising demand. There have been mountains of evidence. Goldman Sachs economist Broadbent and Daly researched 44 large fiscal adjustments in 24 advanced economies since 1975 concluded that reducing expenditure by 1% boosted growth by 0.6%. (see reference #3)

Let us see who is right, who is wrong. In my opinion Krugman's suggestion is more plausible.

Reference:

1. http://www.economist.com/blogs/charlemagne/2010/02/greeces_generous_pensions
   
2. http://www.nytimes.com/2010/06/21/opinion/21krugman.html?ref=paulkrugman
   
3. http://www.bloomberg.com/news/2010-06-21/cameron-bets-on-prosperity-from-austerity-while-obama-pushes-more-stimulus.html