By James Kwak
We appear to be a week way from an election that, while really about persistent high unemployment, on the talking-point level is largely about deficits, with the Republicans continuing their usual posturing about cutting deficits without raising taxes or explaining what spending programs they are going to cut. Robert Pollin has contributed an analysis of the deficit hawks’ argument that is valuable for pointing out that there actually four deficit hawk arguments. In his words:
“1. The traditional view. Large fiscal deficits will cause high interest rates, large government debts, and inflation.
“2. Declining business confidence is the real danger. Even if the current deficits have not caused high interest rates and inflation, they are eroding business confidence. When business confidence is low, the economy is highly vulnerable to small changes in conditions, what some economists call ‘non-linearities.’
“3. Fiscal stimulus policies never work. New Classical economists, Robert Barro most notably, have long argued that the multiplier for fiscal stimulus policies is zero or thereabouts.
“4. A long-term fiscal train-wreck is coming. Regardless of short-term considerations, we are courting disaster in the long-run with structural deficits that the recession has only worsened.
Pollin also has the grace to point out that, for the deficit hawks to be correct, only one of these arguments has to be correct.
Of course, they’re not, at least not the first three. To the first argument, Pollin largely follows the Krugman line, pointing out that interest rates and inflation remain stubbornly low, with the risk of deflation outweighing the risk of inflation. With excess capacity and high unemployment, it’s hard to see what private sector investment there is for the government to crowd out.
The second argument is the one popularized by Carmen and Vincent Reinhart and Ken Rogoff. Its appeal is that it bypasses the Krugman argument (interest rates are low, not high) by hypothesizing that at some point, investor sentiment tips and interest rates suddenly skyrocket. Now, this is certainly true at some point, and given the limited data (there just aren’t that many countries in the history of the world with our economic influence and control over the world’s reserve currency), there is no trustworthy empirical answer to the question of when confidence crumbles away. But I’m with Pollin on this one. Why panic over an unquantifiable risk of an unquantifiable tipping point when (a) there are no data saying we’re close to one and, more importantly, (b) we know there is a very real risk of economic stagnation? Not only is there a risk of stagnation, we have stagnation right now–just ask all the people without jobs. In the long term, confidence in the ability of the Treasury to pay off its debts is based on expectations about the future performance of the U.S. economy (since the economy is the tax base), and the bigger worry right now should be economic growth.
The third argument is the old one about multipliers, and the short answer is that the vast majority of the empirical work says that multipliers are positive, even for tax cuts, and multipliers for spending are often over one (see Blinder, Zandi, Chinn, et al.).
The fourth argument is the one where I think the deficit hawks might have a point, although their usual solutions (austerity now!) are wrongheaded. Pollin’s rebuttal is that the average fiscal deficit over the next decade is projected by the CBO at 5.2% of GDP (using the administration’s proposed budget, which includes extending most of the Bush tax cuts), and we can easily get that down to 2-3% of GDP through some combination of lower health care costs, lower military spending (e.g., just getting somewhere close to 2000 levels), and a financial transaction tax. I think he’s basically right as far as the next decade goes, but after 2020 the problems with Medicare start to take off, and those problems are largely outside the government’s control: Medicare is just an insurance plan to pay for privately delivered services, and those services are what is skyrocketing in price. So this gets into the debate about how much the recent health care reform bill actually reduced long-term health care costs, which is a messy and as yet unresolved debate.
But as I’ve said before, if you take argument #4 seriously, the answer has to be curbing the long-term growth of healthcare costs, not cutting government spending now, which is basically irrelevant to the “structural” deficit and, worse yet, will only worsen and prolong the recession.* And the answer has to be curbing healthcare costs in general, not just the government’s share of those costs, because otherwise you’re just shifting the risk onto people who cannot afford to bear it.
* From now on, I’m not going to bother pointing out that, according to the NBER, the recession ended a year ago. You know what I mean.