I have long been neglectful of Prof. Larry DeBoer’s (Everybody’s Favorite Economist ™) Capital Comments. November’s installment explains the “fiscal cliff” and why going over it is a bad idea.
Come Jan. 1, the Bush-era tax cuts expire, so everyone’s tax rates will increase. The two-year cut in the Social Security payroll tax will expire, raising taxes some more. The Alternative Minimum Tax won’t be adjusted for inflation, so millions of people will see their taxes rise still more. Automatic spending cuts will kick in, reducing both defense and entitlement spending. Extended unemployment insurance will expire; so two million people will lose benefits. And Medicare payment rates to doctors will be cut.
All told, it yanks about $500 billion out of the economy. That’s bad. But it cuts the deficit, that’s good, right? Well, yes, but it’s a matter of competing priorities. Pick you poison – slow or receding economy on the one hand or large deficits on the other. Right now, the deficits are the lesser poison because there is a lot of idle capacity in the economy. Demand created by the government isn’t pushing out or competing much with private sector demand so, at the moment, printed money isn’t driving inflation. In fact, interest rates are very low.
Yank the deficit money out of the economy, and businesses will have less reason to produce goods and services, will cut production, and you probably end up in vicious circle territory.
It’s a nasty choice: recession and unemployment now, or high interest rates, inflation and slower growth later.
DeBoer recommends coming up with a plan now that tackles deficits when the economy has recovered, not while it’s in the process of recovery.
{ 14 comments… read them below or add one }
This is good analysis. Going over will likely trigger a recession, and it will signal markets that America’s political gridlock is making the nation ungovernable.
We are currently on a “Chickie Run” ala “Rebel without a Cause.”
Who jumps out first?
I was chose as the 8th Favorite Economist™. For those who might be interested in the first of the two-part series: http://schansblog.blogspot.com/2012/11/the-fiscal-cliffs.html
This was first of three cliffs I presented at Wabash. The third links Harrington’s classic “Other America” with Murray’s must-read “Coming Apart” on the social cliff we face. You’ll get a big kick out of that one.
People like DeBoer and Krugman, who advocate deficit spending ad infinitum, are often mistakenly called “Keynsians”. But Keynes advocated increased government spending only during recession.
DeBoer is a bloody fool. Japan has been priming the pump for 20 years and their economy is still in the doldrums, with a debt:GDP ratio over 200%.
The “fiscal cliff” outcome is better than digging a deeper hole. Government debt is naked intergenerational wealth transfer.
The US hasn’t had a real surplus since 1970. The surplus under Clinton was just an accounting trick.
If you think DeBoer is a fool, you can’t be the sharpest tool in the shed yourself. Disagree if you like, but mind your manners.
But this is interesting. Transfer from whom to whom? I mean I get that you’re saying that our kids will be paying for the stuff we enjoy. But who will the children of the world be paying?
Gene
No one is suggesting permanent UNSUSTAINABLE deficits (athough a n Romney regime would have magnified the deficit).
And to call the Clinton surplus other than that is disingenuous.
The Bush tax cuts put this country back into deficit spending. The Bush administration’s failure to regulate the secondary trading of MBS through the nation into the Great Recession.
Well, it sounds like Gene is suggesting that the U.S. will never return to prosperity; at least that’s the inference I take from Japan’s 20 year doldrums and blowing off DeBoer and Krugman’s recommendation that we pay off debt when the economy is strong.
So, what? We settle up and close down the business? This is, I suppose, an example of why the running a government like a business metaphor takes you only so far.
This is why I find the irony of the Republicans being the party of “we can’t go further into debt” so delicious. They accelerated the deficit with GWB because it was bad to pay the debt back too quickly, among other reasons.
If the Republican Party is serious, they will come out with their own deficit reduction proposals rather than just complain about what Obama has to offer. That they have not so far tells me they know their plan will not be well received.
I agree with the overall point about deficit spending, now is not the time to focus on debt reduction.
But, the “cliff” doesn’t happen in one big drop. We only “yank about $500 billion out of the economy” if we go past Dec 31, and we also assume that no legislation will be passed in the next calendar year to change the trajectory. Let the tax rates go up for a few weeks; yes, the average American will have a few hundred dollars less in his paycheck; yes, that will sting. But at that point there will be enormous pressure to pass some tax relief for the vast majority. I have a hard time believing that the repubs will stand against that for long, even if the 1% gets left behind this time. And the tax revisions can be made retroactive.
Same on the spending side. Come January, Congess will be anxious to restore payments to defense contractors among others. So the sequestration items will be restored piecemeal, and pieces and parts will be negotiated that will pretty much put the numbers back where they were.
Now, as far as the chances of getting any actual addtiional stimulus spending included, that I’m not so hopeful about.
Some interesting points particularly in view of some of the comments made:
Increase in National Debt during term of Presidents: (I know taken from an extensive table on the web.)
Carter 42.3% (4 years)
Reagan 188% (8 years)
Bush 55.6% (4 years)
Clinton 35.6% (8 years)
Bush 89.6% (8 years)
Obama 41.4 % (4 years)
Now realize that the president does not ever cast a vote for or against budgets except the power of veto which may be threatened but has seldom ever happened.
Jack,
that may be the case, but overall Obama has grown the federal deficit slower than any president since Eisenhower:
President:…….Avg. % base increase….Avg. % increase adjusted for inflaction
Johnson……………11.0…………………………………….6.3
W. Bush…………..10.2…………………………………….5.9
Kennedy…………..7.1……………………………………..4.7
Carter……………..16.4…………………………………….4.2
Nixon……………..13.5…………………………………….3.0
Reagan……………..8.6…………………………………….2.7
H.W. Bush………..5.8…………………………………….1.8
Clinton…………….4.0……………………………………..1.5
Obama…………….1.6…………………………………….-0.1
Eisenhower…….3.6…………………………………….-0.5
The deficit will continue to shrink, hopefully Obama is able to ensure that it does not shrink too fast. I agree with Prof. DeBoer that continuing to slowly reign in spending is better than the alternative of progress-stalling austerity programs (which, have not worked well when implemented in Europe).
With respect to Gene’s earlier comment about Japan being an example of stimulus not working, I found a discussion that claims the reason for this is that the stimulus in Japan hasn’t been sustained – they pull it back intermittently and have derailed their recovery. (Sounds a little like when folks take antibiotics only as long as the symptoms persist but not long enough to kill off the germs entirely.)
Doug,
Good analogy with taking the antibiotics until the symptoms reside. Stimulus is often withdrawn to soon. Many see 1937 as the year FDR eased stimulus and guess what?
A side point, but even those that did not see the error of 1937 and curse FDR until the face on the dime melts, will state that WWII ended the Great Depression. Well, what happened economically during WWII? Massive debt spending on assets that were destined to be destroyed by the enemy or sold for scrap. And in 1945, US debt was at 113% of GDP.
And this year, Japan’s Debt:GDP ratio was 111% in 2011.
Below is another good article on the Japanese situation.
http://www.bloomberg.com/news/2012-06-04/japan-s-debt-sustains-a-deflationary-depression.html
Deficit hawks always sing a tempting song. Things may be starting to turn around. Now let’s start contracting. It is the “virtueous” thing to do. Well, they don’t state it that way, but in a liquidity trap and business uncertainty, even zero interst rates do have many takers. So you slip back into the doldrums.
The stimulus should continue until the recovery is strong and the bitch is really about the inflation.
Also, Doug, were you an Econ major? You think like one. And that is a compliment.
Ha. Thanks and no I wasn’t an econ major. My formal economics training consisted of 9 weeks in high school. But I was a history major and economics tends to seep in there from time to time.