*When* should consumers cut their spending?

Paul Krugman argues:

Sooner or later, then, consumers were going to have to pull in their
belts. But the timing of the new sobriety is deeply unfortunate. One is
tempted to echo St. Augustine’s plea: “Grant me chastity and
continence, but not yet.” For consumers are cutting back just as the
U.S. economy has fallen into a liquidity trap – a situation in which
the Federal Reserve has lost its grip on the economy.

….The capitulation of the American consumer, then, is coming at a
particularly bad time. But it’s no use whining. What we need is a
policy response.

Krugman then calls for fiscal stimulus, as has Martin Feldstein.  I am more inclined to think that consumers need to cut their spending now.  It is widely understood that consumers have been living beyond their means.  Let us say instead that consumers maintain their spending (say through fiscal stimulus, a cut in sales taxes, or sheer exhortation) but that everyone knows consumer spending will fall in three years time.  In three years time, the "liquidity trap" (not exactly how I think of it) will be over, but in the meantime investment commitments will be lackluster, given that people will be waiting for the economy to digest the forthcoming change.  Maybe we need to spend less now and get the adjustment over with more quickly, even though that will be painful.  Or say we don’t know when the spending decline will come — markets often dislike uncertainty most of all.

I view the goal as hurrying up needed sectoral adjustments and minimizing unneeded or temporary sectoral adjustments.  That suggests any "stimulus" funds, whatever their magnitude, should go to preserving expenditure patterns of state and local governments.  Such an allocation also ensures that the money will be spent, if indeed that is the goal.  Greg Mankiw offers a related idea.

The St. Augustine quotation in Krugman’s column is apt.  Do many people in fact use temporary sex as a successful path to abstinence?  Some do, yes, or at least so I have heard.  But it would be odd to accept such histories as the default view of how to get there.

Addendum: Excellent comments from Interfluidity.


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