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WASHINGTON, DC "â?? Democratic and Republican leaders in Washington are suddenly falling over themselves to agree on the need for major tax cuts "â?? affecting not just middle-class Americans, but also very rich people (both living and when they die). Does this sudden outbreak of the long-desired bipartisan consensus indicate that a new, stronger America is just around the corner?
Unfortunately, the opposite is true. What we are seeing is agreement across the aisle on a very dangerous approach to public finance: a continuation and extension of what President George H.W. Bush memorably called "voodoo economics."? Its consequences are about to catch up with America, and the world.
Bush was competing with Ronald Reagan for the Republican nomination in 1980. Reagan suggested that tax cuts would pay for themselves, i.e., actually raise revenue "â?? a notion that became known as "supply side"? economics. There's nothing wrong with worrying about the disincentive effect of higher taxes, but the extreme version put forward by Reagan did not really apply to the United States. When you cut taxes, you get lower revenue, which means a bigger budget deficit.
To be sure, no serious people are claiming the full Reagan effect today "â?? partly because the Congressional Budget Office has kept everyone honest by showing in detail that the tax cuts will increase the deficit by close to $900 billion. But there is a broader Reagan-type reasoning at work here: unemployment is high, the economy is not growing fast enough, and we "need a fiscal stimulus."? For those who generally like lower taxes, of course, this, too, is wishful thinking.
Experience with fiscal policy over the past few decades is clear. It is worth stimulating the economy with discretionary fiscal policy only occasionally "â?? specifically, when not doing so would be calamitous. Thus, it made sense to pursue a fiscal stimulus of some kind in early 2009.
More generally, fiscal stimulus is unlikely to have much lasting effect, as is the case now. There may be some temporary positive impact on demand, or higher interest rates could offset the entire fiscal push "â?? rates on the benchmark 10-year Treasury bond are up significantly from a month ago (from 3.21% to 4.16%), when the discussion of tax cuts began in earnest.
The market is nervous "â?? mostly about the prospect of large fiscal deficits as far as the eye can see. Some commentators dismiss this as irrational, but, again, that is wishful thinking. The path-breaking work over many years of Carmen Reinhart, my colleague at the Peterson Institute in Washington, makes this very clear "â?? no country, including the US, escapes the deleterious consequences of persistent large fiscal deficits. (Indeed, her book with Ken Rogoff, This Time Is Different, should be required reading for US policymakers.)
In this environment, a further fiscal stimulus may prove counterproductive, with the extra spending counterbalanced by the negative effect on the housing market of higher interest rates. The US Federal Reserve promised to hold down longer-term rates, but its commitments in that direction now seem ineffective.
But that is not the real danger here. Most American politicians like to think and talk only about the US. But longer-term US interest rates are very much affected by what happens in the rest of the world "â?? and how private-sector investors view US government debt relative to other countries' sovereign debt.
The eurozone's problems certainly help the US sell more debt at lower prices "â?? for now. But the chances are high that the eurozone will sort out its difficulties in a year or so (most likely after another round or two of crisis), in part through the judicious use of fiscal austerity. It would make complete sense if a German-led core emerged stronger and more politically integrated than before "â?? within a eurozone that has a different composition, a different structure, and very different rules. This presumably more fiscally unified political entity would be highly attractive to investors.
A year from now, what kind of economy will the US have? Any short-term "fiscal stimulus"? effect will have worn off, unemployment will still be high, and there will no doubt be politicians clamoring for more tax cuts. The budget deficit will likely be in the range of 8-10% of GDP, even if growth comes back to some extent. And the bond markets will be much more nervous, meaning higher interest payments, which will widen the deficit further. We might also be looking at a potential ratings downgrade for US government debt "â?? implying the prospect of even higher interest rates.
Some people expected Paul Ryan, a rising star within the Republican Party who will become Chairman of the House budget committee in the next Congress, to provide a fiscally responsible anchor to the next round of the deficit debate in the US. Writing in The Financial Times in early November, Ryan suggested, "America is eager for an adult conversation on the threat of debt."? But all indications are that he is just as childishly reckless on fiscal policy as most of his Republican colleagues since Ronald Reagan.
Unfortunately, there is no sign yet that the Democratic leadership is ready for a mature conversation about fiscal consolidation, either. Both parties' leaders will get there "â?? but only when dragged, kicking and screaming, by the financial markets.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, and a senior fellow at the Peterson Institute for International Economics.
Copyright: Project Syndicate, 2010. www.project-syndicate.org
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Username Password New registration Forgotten password lukehlee 06:10 15 Dec 10Prof. Johnson,
Usually, we want the facts to fit the preconceptions. When they don't it is easier to ignore the facts than to change the preconceptions.
I have discovered a serious mistake as a fact made in the market over the last 20 to 30 years of the Modern Information Age. I believe it has created a maddening economic condition in the market or economy. If we do not break down the logic of the existing maddening economic condition â?? the real source of our problems - I believe that every new effort will be just as ineffective and useless as everything else we have tried.
I strongly suggest you to see this article: "Breaking Down the Economic Death Spiral â?? and Saving the World Economy" http://t.co/8pMwQh7
Sincerely,
Luke H. Lee
AUTHOR INFO Simon Johnson Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, and a senior fellow at the Peterson Institute for International Economics. MOST READ MOST RECOMMENDED MOST COMMENTED The Irrepressible 1930's Robert Skidelsky Europe's Inevitable Haircut Barry Eichengreen The Retreat of Macroeconomic Policy J. Bradford DeLong Alternatives to Austerity Joseph E. Stiglitz The Euro at Mid-Crisis Kenneth Rogoff A New World Architecture George Soros No Time for a Trade War Joseph E. Stiglitz Avatar and Empire Naomi Wolf Let A Hundred Theories Bloom George Akerlof and Joseph E. Stiglitz The Risky Rich Nouriel Roubini Europe's Inevitable Haircut Barry Eichengreen The Retreat of Macroeconomic Policy J. Bradford DeLong Alternatives to Austerity Joseph E. Stiglitz Thinking the Unthinkable in Europe Dani Rodrik Land for Peace in Kosovo Charles Tannock ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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Prof. Johnson,
Usually, we want the facts to fit the preconceptions. When they don't it is easier to ignore the facts than to change the preconceptions.
I have discovered a serious mistake as a fact made in the market over the last 20 to 30 years of the Modern Information Age. I believe it has created a maddening economic condition in the market or economy. If we do not break down the logic of the existing maddening economic condition â?? the real source of our problems - I believe that every new effort will be just as ineffective and useless as everything else we have tried.
I strongly suggest you to see this article: "Breaking Down the Economic Death Spiral â?? and Saving the World Economy" http://t.co/8pMwQh7
Sincerely,
Luke H. Lee
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 53 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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