When It Comes to Deficit Reduction, Timing Matters

The news that Britain has entered into a double-dip recession touched off a fierce debate last week over the role of austerity in the country's downturn. Many commentators say that the fiscal contraction the coalition government undertook starting in mid-2010 is the primary reason for the UK's U-turn (see here and here for example), while a few others (here, for example) believe that things would have been worse if it hadn't taken been place as evidenced by rising bond yields right before the package was passed. 

In either case, it is important to first note that the United States is not Great Britain -- and declarations of "death to austerity" should not be taken to suggest that a medium-term deficit reduction plan is not needed in the United States; the two are different. Rather than ignoring the problem or putting in place immediate austerity, the United States should enact a gradual and thoughtful fiscal plan that gradually puts the debt on a stable and declining path relative to the economy.

On the British question, it is important to consider the counterfactual: what if UK fiscal policy simply stayed the course? Critics of the coalition government's fiscal contraction believe that concerns about rising borrowing costs were overblown and that, per standard economics, the cuts simply derailed the recovery that was underway. However, defenders of the government's actions believe that economic performance would have been worse had nothing taken place because bond yields would have spiraled out of control and ultimately would have caused more pain than the austerity measures. They point to the fact that yields have subsided relative to German yields since fiscal contraction began as proof of success.

Bond yields are an ambiguous way of determining the effects of economic policies: it could be the result of strengthening confidence in the British fiscal situation or waning confidence in their economy. It is difficult to know for sure what the policies' effects were and how things would have been different in their absence.

Either way, US fiscal policy is not in the same position as the countries that have been undertaking austerity. Treasury rates have remained subdued, at least in part because of the safe haven that Treasuries represent. This is not an excuse for inaction, but it means we can be nuanced about how we go about it. We should enact a fiscal plan now, but we should utilize our luxury to phase in changes gradually. As CBO has explained, such a plan would offer the medium- and long-term benefits of deficit reduction while minimizing the drag on the economic expansion, allow sufficient time to plan, and "provide some boost to economic activity by reducing uncertainty and holding down interest rates."

We have long made the case that there would be a positive "announcement effect" in which enacting a credible longer-term deficit reduction plan can boost the economy in the short term. Importantly, this announcement effect is not contingent on substantial deficit reduction occurring early while the economy is still weak, but rather on the plan being enacted at that time. In addition, people should not expect the increased confidence to be large enough to fully offset the contractionary effect of whatever short-term deficit reduction does occur. Rather, the confidence effect could help ease what short-term pain does occur, and do so without any reduction in the long-term gain associated with deficit reduction.

Former Obama Council of Economic Advisors chair Christina Romer recently made this case. As she explained:

The best policy [in the United States] is to combine the backloaded consolidation I’m recommending for troubled countries with the short-run stimulus I’m advocating for countries like Germany. We could enact something like the Bowles-Simpson plan to reduce the deficit sharply over 10 years, and include in it more near-term investment in infrastructure, education and scientific research...

These policies are nuanced, so they are easily caricatured as doing something with one hand and undoing it with the other. Their key element is dynamics — using credible plans to lower borrowing costs and address long-run fiscal problems, while not taking immediate austerity measures that would raise unemployment when what countries need most is growth.

In deficit reduction, timing is essential. Lawmakers must carefully balance short- and long-term economic goals. But with the right timing and the right composition, a comprehensive fiscal plan offers a lot more up side than down side to the U.S. economy.

It is interesting that Europe

It is interesting that Europe going into a double-dip recession is not sounding off alarms with more people than it already is. It still seems that there are so many people who want every country to operate the way they do. Socialism is not the answer, apparently.

 

 

It will never cease to amaze many people that there are those who still believe that having the government taking care of the payout percentage is the way to go.

Economic Myopia

The debate between capitalism and socialism goes back to the day of Charles Dickens and the excesses of capitalism. What has significantly changed is globalization and automation, and the expansive privatization of the common wealth (environmental resources) without including the cost in the pricing of goods and services. The free market is subject to automated speculation that causes pricing bubbles that collapse when actual demand takes delivery of commodities. Economies are about real people who need or desire goods and services, not the manipulation of financial speculators who look to increase their wealth at the expense of the public welfare. It is the well-being of the public that creates wealth and rewards investment.

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