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Time for grown-ups to make gradual, measured cuts

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By James McCusker
Herald Columnist
Published:
One of the things our founding fathers left out of the Constitution was a parent to guide and mediate the arguments between the separate powers of our government. How could they have missed that?
The federal debt issue is providing a case study in what happens to the governmental equation when maturity is subtracted from each side of the issue. We get pouting on one side, foot stomping on the other -- and there is no parent to watch over the fracas to make sure that it doesn't go too far.
A good parent or good CEO recognizes when a disagreement is spinning out of control and intervenes -- "Who wants ice cream?" -- to reset the terms of the arguments or redirect the energy toward another purpose. The Constitution, though, does not include any provisions for parental guidance, ice cream or any other means of restoring maturity to overstimulated arguments between the executive and legislative branches.
What we are left with in this case, then, is a chief executive who believes that unlimited federal spending is part of a cost-free electoral mandate and a House of Representatives that believes that unlimited federal spending threatens the country's financial system on which our prosperity and security are based.
How did they get so far apart? Some of it is pure politics, of course. Underlying that, though, are two fundamentally different views of how an economy works.
Nothing illustrates these different views better than the views of Olivier Blanchard, who recently offered advice on U.S. levels of spending. Blanchard is the chief economist for the International Monetary Fund, and is clearly a grown-up -- a species that has little chance of survival in the desolate federal debt and spending argument but can exist only in its fertile fringes. And Blanchard also illustrates the views of the news media and Internet bloggers, whose selective quotations turned his essentially sound advice into a hymn for the renowned Spendarazzi Choir.
Blanchard and a colleague at the IMF, Daniel Leigh, recently co-authored a working paper titled "Growth Forecast Errors and Fiscal Multipliers." Ordinarily a title like that would attract as much media attention as a press release from an ant farm distributor, but this is no ordinary technical paper. It touches on enough economic theory questions to fuel a graduate seminar on macroeconomics and economic policy.
At its pragmatic center, the paper is an exploration of the effects of planned government cutbacks on economic growth. The short version of what they found was that in the advanced economies, substantial cutbacks in government spending reduced economic growth more than forecasters had expected.
The economic forecast models of the type the IMF and others use, involve "fiscal multipliers," estimates of what happens when a government raises or lowers its spending.
Since in this study the governments that cut the most spending were those whose economic growth was most disappointing -- that is, below forecasts -- the authors conclude that the fiscal multipliers must have been underestimated. The negative impact of government spending reductions, the so-called "austerity" measures, was greater than had been generally believed.
The theory behind fiscal multipliers belongs to followers of John Maynard Keynes, of course. He was a brilliant economist and the theory is both sound and helpful, if we were dealing with the same conditions … but we are not.
One difference is that Keynes recommended government intervention -- and deficit spending -- in the 1930s, when government debt was manageable and mostly a matter of "money owed to ourselves." Increased government spending, funded by debt, could draw out idle funds from citizens and domestic businesses. Other countries' money was not in the picture.
The austerity programs in Europe recently were mostly not voluntary, and most assuredly not a domestic matter. The outside credit sources for these countries had dried up and domestic resources were tapped out. And the bulk of government spending wasn't investment but transfer payments to consumers. There's no Keynes there.
Despite the issues with fiscal multipliers, the most significant recommendation that Blanchard and Leigh made was very reasonable: Do not underestimate the economic impact of government cutbacks. In practical terms, smaller cuts over time are better than the searing pain of dramatic cuts forced upon the government when its credit card is shredded.
We can all agree on that. And we can probably agree on his advice that the tax increases recently imposed are probably enough for the economy this year.
Agreement stops, and the pouting and foot stomping begin when we have to implement the underlying principle of reduced spending. It's tough, apparently, for some to recognize that spending-related debt is a problem that neither more debt nor higher taxes can solve in the long run. Who wants ice cream?
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.

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