This article discusses the policy dilemma that Japan faces in order to get the economy out of its decade-long deflation.

American fiscal policy over the last decade has been somewhat procyclical, that is, destabilizing.    The U.S. government wasted the opportunity of the expansion period by running large budget deficits.   As a result, Washington in 2010 feels constrained by inherited debts to withdraw fiscal stimulus at a time when the economy is still weak.  Some emerging market and developing countries have learned how to run  countercyclical fiscal policy – saving in the boom and easing in the recession – during the same decade that rich countries forgot how to.    

The frenetic debate as to what current fiscal policy should be is of less consequence than what is the longer term regime.   When the United States was able to take advantage of the 1992-2000 boom to eliminate its budget deficit, the key legislation had been enacted in 1991 and 1993.   The deficits of the last ten years were created by legislation of 2001 and 2003.   Americans need to take a perspective longer than the annual budget cycle or the bi-annual electoral cycle [let alone the news cycle].   Bringing back intelligent fiscal policy means taking steps today to lock in long-term progress toward fiscal responsibility (such as enacting social security reform) while yet avoiding any steps that would withdraw short-term fiscal stimulus while the economy is still week.

It would help to have institutions that might insulate fiscal policy from some of the vagaries of politics.    Chile has achieved countercyclical fiscal policy over the last ten years by means of some institutions that could usefully be adopted by other countries.   Chile has a rule that targets a structural budget deficit of zero.  But that is not enough in itself, as the failures of Europe’s Stability and Growth Pact illustrate.   The key innovation that others might adopt from Chile is to vest responsibility for determining whether a given year’s deficit is structural or temporary in a panel of independent experts.   The alternative is that politicians, inclined to wishful thinking, forecast that booms will continue indefinitely, with the result that revenue is spent rather than saved.  

Arguing that the pegging of the renminbi to the dollar hurts the entire world, some analysts have called for the emerging-market economies to join the United States in pressurising China to allow its currency to float.  I argue that these calls rest on very suspect arguments and that India will be ill advised to open yet another India-China controversy. 

Social expenditure in India, inclusive of the food subsidy, has risen modestly over the last ten years to cross the 30 per cent mark in its share of total public expenditure, aggregated over all levels of government (8.3 per cent of GDP).  The constitution assigns responsibility for social functions largely to subnational states, but states’ share in social expenditure has actually fallen to 74 per cent, from 79 per cent ten years previously. Large national (Central Government) schemes for education, health, and the rural employment guarantee, have been motivated in part by impatience with social outcomes, but have resulted in blurring of responsibility.  Some Central schemes are partially delegated to local government, but the fiscal role and accountability of local government need to be systematized so that ordinary people can have a greater say in the configuration of social expenditure.