I've been pushing fiscal conservatism for a long time. I decried the fiscal budget deficits that ballooned under Ronald Reagan, and I celebrated the budget surpluses eventually achieved by Bill Clinton and the Republican Congress by the late 1990s. I decried again the profligate waste of that surplus under Bush II (see graph).
But while I'm a fiscal conservative I'm also a modified new Keynesian. Counter-cyclical fiscal and monetary policies can and should be used during severe downturns to bolster aggregate demand. Stimulus should be withdrawn during boom periods, producing a fiscal surplus (as happened during Clinton's second term).
Critics, though, have a good point: Keynesian is a dangerous tool. Government programs create political constituencies; stopping a program once started is nearly impossible. That can lead to ever-growing government entitlements and ballooning spending. Hence, counter-cyclical fiscal spending should be tied to specific, limited projects with sunset clauses, e.g., road construction, port construction, and so on. If you can't trust Congress and the President to agree to these limits then critics argue (with some justification) that nothing is better than something.
But others oppose Keynesianism by advocating a reverse Keynesian model—arguing that austerity policies (cutting federal, state and local spending) can be used to magically revitalize demand in the private sector. This is a wonderful idea, but flouts all the evidence when we are in a recession.
Businesses have no incentive to expand when they have excess capacity and demand is weak. Austerity in the face of recession increases unemployment, lowers growth, and further undermines consumer and investor confidence—and hence may increase the very deficits austerity is supposed to cure. That seems self-evident.
Krugman has been beating this drum and it is worth repeating: Ignoring the economic theory of demand in favor of wishful thinking isn't very scientific—nor is it ethical. This week's Economist notes that austerity policies are rapidly running up against the wall of conflicting data in Europe.
I am sympathetic with those who worry about the size of government and its deficits. But I'd rather we borrow at current low rates to fix infrastructure when labor and materials are cheap rather than waiting to do this in five years when the opposite may be the case. And I also worry about a generation of lost workers who will be permanently scarred by a really bad job market—particularly the young—pushing down labor participation rates as people become discouraged. This is bad for families, bad for communities, and bad for the long run financial health of the country.