Bear with me, but the following is sort of dense and difficult to absorb, but I believe it is essential in understanding what to do about the state of our (and the world) economy, beyond the “cut spending at all costs” meme dominant today:
David Stockman, Republican Ronald Reagan’s budget director, said this on 60 Minutes last night, when asked by Leslie Stahl what he meant by “Tax cutting is a religion“:
Well it’s become in a sense an absolute. Something that can’t be questioned, something that’s gospel, something that’s sort of embedded into the catechism. And so scratch the average Republican today and he’ll say “Tax cuts, tax cuts, tax cuts.” It’s rank demagoguery. We should call it for what it is. If these people were all put into a room on penalty of death to come up with how much they could cut, they couldn’t come up with $50 billion, when the problem is $1.3 trillion. So, to stand before the public and rub raw this anti-tax sentiment, the Republican Party, as much as it pains me to say this, should be ashamed of themselves.
However, Stockman doesn’t just criticize Republicans for their demagoguery:
We have now got both parties essentially telling a Big Lie. With a capital ‘B’ and a capital ‘L’ to the public: and that is that we can have all this government—24 percent of GDP, this huge entitlement program, all of the bailouts—and yet we don’t have to tax ourselves and pay our bills. That’s delusional.
It is delusional, if Democrats are determined, like Republicans, to make the tax cuts permanent, forever and ever. Americans of all income groups are taxed less today than in 1982, the beginning of the age of hyper-deficit spending. And despite David Stockman’s role in that unfortunate age, he is willing to admit that the tax cut hysteria is wrong. It is wrong arithmetically and it is wrong morally, given all that needs to be done in our country.
But because of the slow economic recovery, the answer is not to raise taxes on all Americans right now, when there is still some risk of a return to the 2008-2009 decline or worse. Extending the Bush tax cuts on all incomes up to $250,000 is the prudent thing to do for the next couple of years, until we are safely removed from the threat of economic regression. It is a good bet that a large amount of that tax-cut money will get spent—it will circulate—and act as a stimulus for the economy as a whole.
But, as Paul Krugman has pointed out, the current opinion regarding the world’s economic situation is on the side of those who,
demand fiscal austerity from everyone; to reject unconventional monetary policy as unsound; and of course to denounce any help for debtors as morally reprehensible. So we’re in a world in which Very Serious People demand that debtors spend less than their income, but that nobody else spend more than their income.
Following that advice, Krugman argues, will result in a continuation of the economic slump, “a prolonged period of economic weakness that actually makes the debt problem harder to resolve.”
And here’s why:
The background to the world economic crisis is that we went through an extended period of rising debt. Now, one person’s liability is another person’s asset, so rising debt made the world as a whole neither richer nor poorer. It did, however, leave the borrowers increasingly leveraged. And then came the Minsky moment; suddenly, investors were no longer willing to roll over, let alone increase, the debts of highly leveraged players. So these players are being forced to pay down debt.
The process of paying down debt, however, must obey two rules:
1. Those who pay down debt must do so by spending less than their income.
2. For the world as a whole, spending equals income.
It follows that
3. Those who are not being forced to pay down debt must spend more than their income.
But here’s the problem: there’s no good mechanism in place to induce those who can spend more to do so. Low interest rates do encourage spending; but given the size of the debt shock, even zero rates are nowhere near low enough.
So since the world economy can’t raise the bridge, it is lowering the water: without sufficient spending from those who can, the only way to make the accounting identities hold is for incomes to decline — specifically, the incomes of those not constrained by debt must decline so as to create a sufficiently large gap between their (unchanged) spending and their incomes to offset the forced saving of debtors. Of course, the mechanism here is an overall global slump, so the debtors are squeezed as well, forced into even more painful cuts.
If you have followed this argument thus far (I have left out Krugman’s discussion of inflation as a mechanism for eroding debt obligations), you can guess the remedy:
To avoid all this, we’d need policies to encourage more spending. Fiscal stimulus on the part of financially strong governments would do it; quantitative easing can help, but only to the extent that it encourages spending by the financially sound, and it’s a little unclear what the process there is supposed to be.
Oh, and widespread debt forgiveness (or inflating away some of the debt) would solve the problem.
As I said, this stuff is a little hard to understand, and in some cases, digest. But the bottom line is this:
1. We need more spending to ensure we don’t go into another severe recession, or God forbid, a depression.
2. In the absence of, or in addition to, effective policies to increase private-sector spending, government spending by those governments strong enough to do it is vital for a stronger economic rebound.
3. The long-term debt needs to be addressed by adjusting government revenue to spending in a rational and sustainable way. (However, if Republicans have their way, spending will be adjusted to insufficient revenue.)