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The Return of Fiscal Policy

Public debt is not a free lunch in an economy close to full employment. But when investment demand tends to fall short of saving, as it does when monetary policymakers are unable to push inflation higher to reduce real interest rates, there is a risk of chronic underemployment – and a stronger argument for deficit spending.

FRANKFURT – Five years ago, the French economist Thomas Piketty made a splash with his book Capital in the Twenty-First Century, in which he argued that there is an innate tendency toward wealth concentration in market economies. The mechanism to which Piketty pointed was that the rate of interest, r, is higher than the rate of economic growth, g. With r>g, owners of the means of production – the capitalist class – earn a return that exceeds the growth of the economy as a whole. 

By highlighting the problem of wealth inequality and providing a pithy explanation of it, Piketty struck a chord. Not many economics books sell more than a million copies.

Earlier this year, another French economist, Olivier Blanchard, the outgoing president of the American Economic Association and a former chief economist of the International Monetary Fund, gave an acclaimed address in which he argued that the debt-carrying capacity of the advanced economies is greater than commonly supposed. The basis for his conclusion was that the rate of interest was less than the rate of economic growth. With r< g, the debt-to-GDP ratio, which measures a society’s capacity to service debts, will have a denominator that is growing faster than the numerator, so long as the budget is close to balance.

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