Normative Narratives

Economic Outlook: An Austerity Program By Another Name Will Be Just As Painfull

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Some of you may remember, way back when Normative Narratives started a few months back, a prickly little topic on every news outlets agenda–The Fiscal Cliff. The Fiscal Cliff was supposed to be an outcome so unthinkable that it forced congress to act and pass a reasonable budget by new years day 2013. While this is no easy task during a recession (partisan gridlock aside), congress had from the summer of 2011 to come up with some sort of deal. Unfortunately, the best our congress could do was kick the can down the road for a bit.

True important tax reforms we’re secured during the Fiscal Cliff debate (raising the top rate on incomes over $400,000 and raising the capital gains tax, as well as keeping Bush era tax cuts in place for everyone else). Not to take anything away from the significance of averting the “fiscal cliff”, but it was at best an incomplete victory. But on the spending side, nothing permanent was decided. Congress was able to agree that the economy would be unable to absorb the shock of spending cuts without causing a double-dip recession / increasing unemployment, and succeeded in kicking the can down the road for a few months. If congress couldn’t figure it out in the year and a half time period between the original debt-ceiling debate and the “fiscal cliff”, was it realistic to think they would be able to reach an agreement on mostly the same issues over the course of two months?

Whether it was reasonable or not, we are currently face-to-face with another austerity program that could indeed send the U.S. economy back into a recession / greatly increase unemployment:

“In less than two weeks, a cleaver known as the sequester will fall on some of the most important functions of the United States government. About $85 billion will be cut from discretionary spending over the next seven months…The sequester will not stop to contemplate whether these are the right programs to cut; it is entirely indiscriminate, slashing programs whether they are bloated or essential…These cuts, which will cost the economy more than one million jobs over the next two years are the direct result of the Republican demand in 2011 to shrink the government at any cost, under threat of a default on the nation’s debt.”

This New York Times article does a great job of highlighting exactly how and where the cuts would take place.

Initially I was going to go through the article piece by piece and explain how each cut could hurt a specific group of Americans. But this is pretty obvious from reading the article, so I will leave it up to the reader to read about specific cuts and make their own judgements. Much less obvious is why these cuts will hurt the U.S. economy overall (and not just specific groups withing the economy). There are two main reasons for this:

1) The Government provides “public goods” that cannot be adequately provided by the private sector

2) We are still in what economists call a “liquidity trap”

First #1. The government provides public goods, such as schooling, infrastructure, and security (military / policing). Public goods are public because they inherently suffer from the “free-rider” problem. Everyone benefits from public goods, there’s no way of excluding someone from benefiting from a better school system, or better roads, or more police officers.  These positive externalities mean that, left up to the private sector, investment in these goods will be insufficient. People will expect someone else to pay for the program and try to reap the benefits for free (hence the “free-rider” problem). Insufficient spending on public goods leads to higher crime (less law enforcement available combined with higher poverty rates due to cuts in social programs), and depresses both current (think poor infrastructure) and future (think inadequate schooling) economic prospects.

The private sector cannot decide to buy public goods just for certain people, as it cannot take advantage of “economies of scale” necessary for public goods to be  affordable. Think how expensive it would be for a rich community to decide to pave it’s own roads, or build it’s own schools, and the security bill needed to ensure other people do not use these services. These bills would be much greater than the taxes otherwise needed to pay for such goods.

But lets suppose that the private sector could make up for this government spending. This is where #2 comes in–the liquidity trap:

A liquidity trap is a situation in which despite very low interest rates (up against the “zero-bound”), private sector funds are not being adequately invested into the economy, but instead dumped into government T-bills (or other low yield but safe asset). A common argument against fiscal stimulus is that it will “crowd-out” private sector spending, and therefore cannot lead to growth. In times of economic growth, this is somewhat true (although not true for “public goods”, as explained above). But in a liquidity crisis, this argument does not hold. Even given incredibly low rates of return, the private sector is unwilling to invest the money needed to create the aggregate demand needed for economic growth / job creation.

If the private sector instead decides it is better to give this money to the government, it should be a strong signal that the government should be spending the money in productive ways (instead of letting it sit in the Federal Reserve, and for it’s part the Fed led by Ben Bernanke has done a marvelous job making sure the economic recovery has not been even more stagnant / non-existent by pursuing unprecedented expansionary monetary policy, known as “quantitative easing”. But this alone is not enough, expansionary fiscal policy is also needed. If stimulus is not politically realistic, contractionary fiscal austerity must be avoided at least.

There is no additional cost to the government spending money, as it essentially pays zero interest on borrowed funds. Given high unemployment, why not put that money to work, and worry about paying it back later? Economically speaking, with an interest rate near zero, and a fiscal multiplier > 1, stimulus spending can be a magic bullet of sorts. Government spending costs the government less now than it otherwise would, and the expansionary effects of fiscal spending are greater now then they otherwise would be. Currently, stimulus is both fiscally responsible and economically necessary to boost aggregate demand (and stimulate economic growth / reduce unemployment / increase tax receipts by growing the economy).

So again here we are; the G.O.P. is playing a game of chicken with “the full faith and credit of the United States of America” (which is one of the reasons we are able to borrow at such low rates despite a relatively high debt / GDP ratio, the fact that American debt is considered “safe”). The effects of a default on our debt  would cripple America’s ability to pursue meaningful monetary policy in the future. The effects of contractionary fiscal policy would depress an already weak U.S. economy (which would send out a ripple effect, depressing global economic growth) and raise unemployment. Yet the G.O.P. is willing to consider these unthinkable scenarios in order to push it’s tried and failed Austerian ideology.

America will have to reign in it’s deficit one day, especially with rising healthcare / social security costs, but that day is not today. Artificially forcing that day to be today, due to the sequester / debt-ceiling, will do nothing but hurt America’s credibility as an economic power both at home (by forcing the government to cut essential programs) and abroad (by making people reconsider whether U.S. debt is a “safe” investment or not).

 

 

 

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2 thoughts on “Economic Outlook: An Austerity Program By Another Name Will Be Just As Painfull

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