In an interesting review of the economy to come, Paul Krugman and Robin Wells channel economist Richard Koo, author of The Holy Grail of Macroeconomics: Lessons from Japan's Great Recession. The most interesting part of the article concerns Japan's response to its recession, which should sound familiar to an American audience:

Most economists discussing Japan's experience over the past two decades treat it as a cautionary tale: year after year of large budget deficits, steadily rising public debt, yet still no full recovery. Koo, however, sees Japan as a qualified success story. In his view, the financial wreckage that occurred when Japan's bubble economy of the 1980s burst could easily have led to a depression-level slump. Japan, however, managed to avoid that fate. The key, he argues, was those much-maligned budget deficits. Japan's fiscal gap, he declares, "is a perfect example of a good deficit," which sustained the economy while the private sector gradually restored its balance sheets to health. The only times Japanese policy went wrong, in Koo's view, were those occasions when policymakers tried to return to budget orthodoxy, in each case setting off a new recession.

Koo argues that today, with the world as a whole in balance-sheet recession, the governments of major economies need precisely to run large fiscal deficits, and to continue doing so until the private sector is ready to spend again. Only then, with the economy no longer dependent on government support, would it be appropriate to shift to deficit reduction.

Read the full story at New York Book Review of Books.

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