He’s had it right all along. Deficits are good during a balance sheet says Richard Koo. Many thought the exploding budget deficit would drive the USA into hyperinflation or even just high inflation. Others said the austerity measures in Europe were going to generate a turnaround. But the one thing we’ve learned from the recent economic downturn is that fiscal deficits during a balance sheet recession are good deficits (via Richard Koo;s latest note):
“This (austerity) is akin to a doctor telling a patient suffering from pneumonia to go on a diet and get more exercise. While exercise is important, it assumes a healthy patient. If the patient is sick, he must build up his strength until he is physically capable of exercising again.
No matter how overweight a patient with pneumonia might be, the doctor’s first task is to give him the treatment he needs to fight the disease. After all, the pneumonia patient can die if treatment is delayed for too long.
Balance sheet recessions, which occur when businesses and households rush to pay down debt in spite of zero interest rates, are a kind of pneumonia. The only way to treat them is for the government to become the borrower and spender of last resort with fiscal stimulus aimed at propping up aggregate demand.
Fiscal deficits during balance sheet recessions are good deficits
All fiscal deficits are good deficits during this type of recession. Once public and private investors realize this, I suspect their decisions will no longer be influenced by the views of those rating agencies that do not understand balance sheet recessions.”