Friday, February 12, 2010

Is Deficit Myopia Leading To A Longer Recession

The outcry about the deficit is making it difficult for government to use fiscal tools to help pull the economy and jobs out of its weakened state. The right fiscal stimulus will reduce the deficit if spending efficiently creates jobs. See the following post from Economist's View.

Joseph Stiglitz:

Obama must resist 'deficit fetish', by Joseph E. Stiglitz: ...Don’t give into deficit fetishism. ... The real risk for America right now is a prolonged weak economy - something that a mindless focus on deficits can help ensure.

The deficit hawks from the banking system went on vacation from the fall of 2008 through the spring of 2009, while they demanded money be doled out freely - to themselves. But now that the public clearly won’t stand for another free lunch at its expense, the deficit hawks are back at work, more vocal than ever about the need to cut government spending.

They say it was necessary to the health of the economy to dole out money to the banks; but not necessary to the health of our society to make sure everyone has access to health care. It was not acceptable to alter the contracts of the AIG personnel, even those “key” and irreplaceable personnel who made the mistakes that led to a $180 billion bailout, but acceptable to break the social contract between America’s elderly and the rest of society, by cutting back on Social Security.

The bankers were short sighted when getting the country into the mess. But deficit fetishism is equally short sighted. ...

Worrying about the deficit can be good, if it focuses attention on four big issues:

(a) What kind of spending yields high returns?

(b) What kind of spending has the largest multipliers? We can increase spending that stimulates the economy a lot, decrease other spending, and still have a stronger economy.

(c) Are there tax increases that will not hurt output and employment, or at least not much? Increasing the progressivity of the tax structure and closing some corporate tax loopholes can, for example, raise revenue and lower the deficit, as employment increases.

(d) Are there other ways of stimulating the economy, e.g. by eliminating some of the problems in access to credit, or inducing banks to lend more for job creation, rather than helping create bubbles? The answer is clearly yes, but that means being a little tougher on the banks than we have been. ...

There are no easy ways out of the mess that the financial sector has created. But giving into mindless deficit fetishism risks higher unemployment...

Deficit fetishism is alive and well, but I'm not sure it is being driven mainly by the financial sector. People like Pete Peterson -- Chairman and CEO of Lehman Brothers from 1973 to 1984 -- are certainly behind some of it, so they aren't blameless either, but it seems broader than that.

The long-run trend line for the deficit is being driven mainly by health care costs. That needs to be kept separate from variations around the trend designed to stabilize the economy through the business cycle. Stabilization policies -- what we need more of right now but won't get due to deficit fetishness -- have little to do with the long-run trend for the budget.

There are two problems that we need to fix. One is the employment problem that exists right now, and we are not doing enough to fight that problem. The last line in the Stiglitz piece above is "The economy needs another stimulus, and it needs it now." I fully agree.

The second problem is the long-run imbalance in the budget, and that can only be solved by health care reform that brings the growth in costs down to a sustainable level. Whether we spend more or less to fight the employment problem that exists right now has little to do with solving this problem, and there's no reason at all for concern about the long-run problem to stop us from doing more now. No reason except deficit fetishness that refuses to separate the long-run health care cost problem from the largely independent short-run needs of those who are struggling to find employment in an economy that is still losing jobs.

This post has been republished from Mark Thoma's blog, Economist's View.

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