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Now Isn’t the Time to Cut the Deficit–But It’s Still a Great Time to Commit to It

October 25th, 2010 . by economistmom

cutting-deficit-nytimes-oct2010

Here’s a very nice column in the New York Times by the only-very-recently-former Council of Economic Advisers Chair, Christina Romer.  The Times gave it the headline: “Now Isn’t the Time to Cut the Deficit”–emphasizing this part of Christina’s message:

Now is not the time. Unemployment is still near 10 percent in the United States and in Europe. Tax cuts and spending increases stimulate demand and raise output and employment; tax increases and spending cuts have the opposite effect. This is a basic message of macroeconomics and a central feature of public- and private-sector forecasting models. Immediate moves to lower the deficit substantially would likely result in a 1937-like “double dip” as we struggle to recover from the Great Recession.

Some advocates of austerity argue that, contrary to the conventional view, fiscal tightening now would lower long-term interest rates and improve confidence so much that the impact could be positive. But an ambitious new study in the World Economic Outlook of the International Monetary Fund confirms that fiscal consolidations — that is, deliberate deficit reductions — typically reduce growth substantially…

Taking budget actions now that would further increase unemployment would be not only cruel, but also short-sighted. The longer unemployment remains high, the more likely it is to become permanent as workers’ skills deteriorate and they gradually drop out of the labor force.

Such a situation would be terrible for both the affected workers and the long-run budget situation. Imagine a patient with a slow-growing tumor who is also recovering from pneumonia. The outcome is likely to be worse if the patient is not given time to recover before undergoing surgery.

But I add to the headline based on this part of Christina’s column (emphasis added):

WHILE immediate fiscal tightening isn’t wise for the United States, we do need to address the deficit. The best thing would be for Congress to pass a plan now that will reduce deficits when the economy is back to normal. France’s recent plan to gradually raise its retirement age to 62 from 60 is a classic example of such “backloaded” reduction. President Obama’s proposal to eliminate the Bush tax cuts on high incomes is another: it would raise revenue by only $30 billion in 2011, but by more than $600 billion over the next decade.

History shows that well-designed backloaded plans are credible. For example, changes to Social Security eligibility and taxes have been passed years, if not decades, before they took effect. And in an environment like today’s, when Congress has again agreed to pay-as-you-go rules, deviating from planned reforms forces countervailing actions.

Such backloaded deficit reduction would not hurt growth in the short run — and could raise it. If uncertainty about future budget policy is harming confidence, as some business leaders suggest, spelling out future spending and tax changes could be helpful. More important, showing that policy makers can come together and make essential decisions about our fiscal challenges would reassure all Americans that our economic future is better than the current grim reality.

That’s the key:  don’t reduce Social Security benefits or raise taxes today, but give Americans the courage, and the rest of the world’s investors the faith, that we can commit to a plan that is full of hard, not-so-pleasant policy changes, but gets us on a sustainable path no sooner than our economy can handle it–but not much later either.

7 Responses to “Now Isn’t the Time to Cut the Deficit–But It’s Still a Great Time to Commit to It”

  1. comment number 1 by: AMTbuff

    >The best thing would be for Congress to pass a plan now that will reduce deficits when the economy is back to normal.

    To be credible, such a plan must guarantee fiscal balance for the rest of this century. That requires a frontal attack on Medicare and Medicaid. If they are not changed in major and painful ways, the plan is not a solution, just more of the same wishful thinking and procrastination. Even the British plan falls in this category: it does not withdraw health care promises that cannot be met in the long run.

    My plan is simple: eliminate Medicare and reduce eligibility and benefits for Medicaid to keep its costs in line. This will restore the safety net to approximately where it was in 1960, and it will allow the safety net to survive the bursting of the Treasury bond bubble.

    If the crisis arrives without any policy change, I believe Medicare and Medicaid will both die, along with part of Social Security. We can greatly reduce the damage by acting now.

  2. comment number 2 by: Country Thinker

    I agree with the call for a credible plan. My concern is that the Deficit Commission’s stated goal is to achieve primary balance by 2015, and I’m not sure that will be good enough, especially if QE results in inflation and higher debt service costs.

    As a lay Austrian, it is unsurprising that I disagree that deficit reduction is inappropriate now, but I offer a different reason than usual. The country is in debt shock, and the mood is sour. I believe that significant deficit reduction right now would boost consumer confidence tremendously.

  3. comment number 3 by: ST Dog

    Passing a plan today is meaningless.

    Congress has repeatedly shown that they cannot live by a plan. Any proposed future cuts will be reversed at a later time when it is politicly expedient to do so.

  4. comment number 4 by: Patrick49

    To paraphrase Winston Churchill, a country trying to tax/spend its way out of a recession/depression is like a man standing in a bucket trying to lift himself by the handle. Today’s economic gurus, Obama, Krugman, Romer et al have not learned anything from FDR’s failure to end the 1930’s depression by massive government make-work spending as chronicled “We have tried spending money. We are spending more than we have ever spent before and it does not work. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises … After eight years of this Administration, we have just as much unemployment as when we started. … And an enormous debt to boot!” — Henry Morgenthau, Franklin Delano Roosevelt’s Treasury secretary, on the failure of New Deal economic-”stimulus” policies, 1941.
    And Obama and his economic team are championing a repeat of the New Deal fiasco.

  5. comment number 5 by: Tommy

    Dear Mom, I certainly appreciate your good intentions here but the reality may be that… at this point in the economic cycle… stimulis $ may be more harmful to employment than good. Here’s why. At virtually 0% short rates, there’s virtually no reason for anyone to invest in the American economy. Just ask the big investment houses on Wall Street, or the big Pension Fund Asset management companies in California. Ask them where they are investing hard earned American $ ? Their answer will most likely be CHINA, BRAZIL, the ASEA nations. How is that helping the American economy in the short run, I ask in good faith.

  6. comment number 6 by: JT

    CUT THE BLOATED DEFENSE BUDGET BEFORE ANY OTHER CUTS ARE ENACTED!

  7. comment number 7 by: Jim Baird

    Well, you’re half right. Cutting the deficit now would be suicidal. But that doesn’t necessarily mean that there need to be “credible plans” to impoverish old people or cut their medical care (which is what the neitral sounding “entitlement reform” actually means…)

    The U.S. is a soveriegn currency issuer in a floating exchange rate regime. Such an entity never needs to more about solvency, or bankruptcy, or the like - it spends by crediting bank accounts. It can never run out of money, and more than a subway can “run out” of tokens.

    Since public deficits = private surpluses, by accounting identity any attempt to cut the deficit or run a surplus must necessarily reduce private savings. This is never a good idea unless the economy is running at such full capacity that it needs to be cooled off.

    In point of fact, deficits are for the most part endogenous - the state of the economy, and the private sector’s demand for financial savings, drive the fiscal balance. You can get there the ugly way (by reducing economic output) or the nice way (by cutting taxes and/or increaseing spending), but hte deficit will increase until the private sector’s savings desires have been met.

    Oh, and Patrick49: the New Deal did work, as dar as it went: unemployment went from over 25% to under 15%, until FDR reversed course and tried to balance the budget in 1937. Or were the people just deluded in voting him back in in 1936 by some of the largest margins in history? And then, starting in 1940,he started an enormous make-work jobs program called “World War II”, ran deficits of 25% GDP for 4 years running, and ended the Depression once and for all.

    If you want to know more about how the modern monetary system actually works, cehck out Warren Mosler’s blog at http://moslereconomics.com.