The federal government’s fiscal year ended October 1, so let’s take a look at the current debt and deficit status. The deficit has gone down a lot — largely due to increased revenues. That’s good news. But, our debt remains very high. And if interest rates rise….
Victorian historian Thomas Carlyle famously called economics the “dismal science.” It wasn’t hard to see why this week (even while important economic news was understandably overshadowed by the horrible events surrounding the Boston Marathon), as politics is getting in the way of some of the serious and substantive policy questions raised by some significant new academic findings.
In research that has been featured prominently in the press and the blogosphere, three economists from the University of Massachusetts at Amherst have cast significant doubt on widely cited findings by Reinhart and Rogoff (RR) which seemed to demonstrate that countries which run up big debts (generally in excess of 90 percent of GDP) suffer a major penalty in terms of economic growth. Continue reading
Virtually everyone agrees that we have a budget and deficit problem. The Democrats would have us believe we have a tax problem while the Republicans would have us believe that we have a spending problem. As the following makes clear, we need both more tax revenue and lower spending.
Source: J.P. Morgan
Source: Political Calculations
Even if we don’t go over the “fiscal cliff” at year’s end, the cries for governmental austerity will only grow louder. Some major measure of fear is understandable in that our federal debt and deficit problem is a big one that needs to be solved. Yet such austerity would be a real and immediate drag on our economy.
Augustine famously prayed for chastity, just not yet (da mihi castitatem et continentiam, sed noli modo). In much the same way, Fed Chairman Ben Bernanke warns that federal debt and deficits are a real problem. Indeed, he gave a speech on the economy earlier this month and asked Congress to address the issue. But he doesn’t want anything done quite yet:
I certainly don’t underestimate the challenges that fiscal policymakers face. They must find ways to put the federal budget on a sustainable path, but not so abruptly as to endanger the economic recovery in the near term.
Indeed, in Europe, heavy austerity seems to have crippled growth in countries like Spain and Greece. With unemployment near Great Depression levels and with middle-class workers reduced to picking through garbage in search of food, austerity arguably appears already to have gone too far. The International Monetary Fund recently released a report conceding that tax hikes and spending cuts can inflict far more damage on weak economies than previously thought. Pretty much everything that has happened economically since the general move from stimulus to austerity, from interest rates to inflation to output, has supported the idea that austerity hurts struggling economies.
On the face of it, these realities suggest that the proper policy approach is to withhold austerity and even to add more stimulus now while the economy is struggling and then, when the economy improves, to deal with the debt/deficit problem. Unfortunately, as good as that theory might be, its execution is likely to be problematic at best.
The sad reality is that there is not a lick of evidence that our political leaders would have the strength and discipline required to impose austerity (which entails a great deal of political risk – stuff people want will have to be cut) when times are good and politicians desperately wish to bask in the glow of success. I suspect that austerity will only be palatable and thus achievable in response to a perceived crisis, and a major one at that. A healthier economy does not a crisis make. Indeed, it won’t be seen as a crisis at all; it will be seen as a reward and yet another opportunity to open the piggy bank.
It’s a major quandary. If we do what is almost surely the right thing in the aggregate, the overall problem is far less likely to be fixed and probably becomes much worse. On the other hand (and ironically), doing the wrong thing by implementing austerity right away will probably provide the better overall result over time.
But it won’t lessen the near-term pain.