"In the US as in the UK the twin deficits (government and current account) severely constrain the government’s fiscal elbow room."

Willem Buiter with another brilliant post. It's kind of scary, actually:

"With the pound sterling dropping like a stone against most other currencies and long-term interest rates on UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland."

Read the post. I can't paraphrase him.

Here's my comment:

“Such mistrust in the temporary nature of a fiscal stimulus would not be irrational. After its first term in office, the government have thrown fiscal restraint to the wind and have engaged in a steady increase in public spending as a share of GDP which has been only partly matched by an increase in the tax burden as a share of GDP. Rising debt and deficits and a fondness for fiscal and accounting gimmicks designed to hide the increase in the debt burden have undermined public confidence in the fiscal rectitude of the government. With enough mistrust, the interest rates will rise by enough to crowd out completely the stimulus to private demand provided by the tax cut or public spending increase. Lack of confidence in the government’s fiscal sustainability would also undermine confidence in sterling. In the worst case, we could see a run on the banks, on the public debt and on sterling all at the same time. This is not the most likely outcome yet, in my view. But it is a distinct possibility.”

I agree with almost everything that you write, in terms of policy. In fact, I would call your writings prudential, which is high praise from me, which it is well you toss in the dustbin. But politically, we’re in a peculiarly tough position. So let me posit my foolishness.

The reaction to Lehman showed the Fed and Treasury that:
1) The markets and investors were expecting intervention.
2) These market people and investors, are very wealthy and very powerful. They told the Fed and Treasury that there’s no Plan B. If you don’t act, we’re clueless as to what course to pursue.
3) Based on earlier actions of yours, we investors, whatever we say in public about free market economics, made not irrational investments based on your intervening. If you don’t intervene now, it will not be seen as prudent and principled, but arbitrary, and arbitrary is political poison. It leads to charges of cronyism, not being principled, having no plan, and you might as well write your name in the history books as looking like a combination of Hoover and Tammany Hall.

So, the Fed and Treasury felt that they had to intervene. Once they did this, well, you can already see where I’m going.

TARP was sold in some quarters as buying toxic assets, read crap, for $700 billion, in order to save bankers. Whatever you think about that, it’s what many people understood.

Now, what about car makers? Does the word arbitrary ring a bell?

Now, you show up, after all this, and say, “Sorry. No more money. No stimulus for average citizens to get us through and out of this recession.Wish we had it. Bankers and automakers got it. Talk to them. See if they’ll share.”

I don’t see this going anywhere in the U.S. I’m not even sure China can afford to tell its citizens we can’t afford a stimulus.

So, the point you made above about mistrust and rational expectations can be made against your point of view. It cuts both ways, rather like ordinary language philosophy can be used for and against the skeptic. It is reason itself that summons the skeptic, and it is rational expectations and mistrust that summon the stimulus.

Posted by: Don the libertarian Democrat