Can we spend our way out of a recession?

President-elect Barack Obama not only feels that we can but believes it is our only option to avoid a years-long crushing of the U.S. economy and way of life. In his speech last week, he said, "At this particular moment, only government can provide the short-term boost necessary to lift us from a recession this deep and severe. Only government can break the vicious cycles that are crippling our economy."

But is he right?

The answer depends on your political ideology and which economist you believe. It is conservative dogma that more government spending is bad, depressing the free markets and individuals ability to spend and invest their own money in ways they see fit. To conservatives such as Victor Davis Hanson of the National Review, the word "stimulus" should be replaced with the words "borrow" or "debt." It is liberal dogma that government has a role in supplementing and policing the free market, especially in tough times.

So let's turn to a foreign voice, someone not entirely caught up in the scrum of U.S. politics. Let's see what Richard C. Koo, the author of The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession and chief economist for the Nomura Research Institute in Tokyo, has to say about such things. (OK, yes, the Taiwanese national is also a U.S. citizen who has done quite a bit of work here in the states and was with the Federal Reserve Bank of New York, but still ...)

Koo's book examines how Japan fixed its economy in the 1990s, when its condition was similar to what the rest of the world is experiencing today. His solution, as boiled down by a writer for Canada's The Globe and Mail: "Spend, spend big, spend till it hurts and when you are tired of spending, spend some more."

The problem in this recession is that the flow of money and credit is impeded by companies and individuals who are either hoarding bash to pay down debt and realign their balance sheets or have lost confidence in the financial institutions that keep cash flowing. Koo's book describes it this way: "There are actually two phases to an economy, the ordinary (or yang) phase, in which the private sector is maximizing profits, and the post-bubble (or yin) phase, in which private sector is minimizing debt, or repairing damaged balance sheets. Although conventional economics is useful in analyzing economies in the yang phase, it is less useful in explaining phenomena such as the 'liquidity trap' that is typical of an economy in the yin phase. The distinction between the yin and yang phases also explains why some policies work well in some situations but not in others."

Koo's solution for the current global and U.S. recession: Turning Japanese.

"By administering the fiscal stimulus, which was also the right thing to do, the [Japanese] government succeeded in preventing a catastrophic decline in the nation's standard of living despite the economic crisis," Koo wrote. "In this sense, it could be argued that Japan's fiscal stimulus was one of the most successful economic policies in human history."

—Wayne Garcia

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