The Paradox of Austerity

An idea I've been hearing from Richard Koo pretty much every time he talks was specifically discussed today by Brad DeLong and Paul Krugman.

The idea - which I am calling the "paradox of austerity" - is that when you're in a "balance sheet recession," if the government tries to cut its budget deficit, the result will actually be increased long-term debt and deficits.  And more specifically, when you're in a "balance sheet recession," cutting budget deficits will cause bigger long-term debt and deficits than if you had engaged in stimulus spending.  It's pretty rough, back-of-the-envelope stuff, but Brad DeLong lays out the math here.  Krugman agrees that a case can be made.  Richard Koo has certainly been beating this drum and Koo claims that when Japan attempted to reduce its budget deficit in 1997, the deficit exploded.

I feel like no one gets this.  The press, of course, doesn't.  But even economists like Kenneth Rogoff say things like "after financial crises, public debt explodes" and then seems to support efforts to cut spending and reduce budget deficits.  However, if Koo/DeLong/Krugman are right about the "paradox of austerity," attempts to reduce the budget deficit may be part of what causes the long-term public debt to explode.

So, someone needs to flesh this out.  Look at Japan in 1997, Japan in 2001 and follow-through on the sketch laid out by DeLong.  Since deficit/debt reduction is the stated policy of pretty much the entire world, I honestly cannot think of something more pressing than knowing whether efforts to reduce the budget deficit will actually explode our long-term budget deficit and debt.