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As of late this summer, Democrats in Washington shared a tidy consensus about the economy: The stimulus was working more or less on schedule, and the job market was gradually recovering. That meant the administration could start thinking about how to rein in the country’s yawning budget deficit, if not actually scale it back yet.
What followed turned that tidy consensus into a pigsty. On October 2, the Labor Department announced that September’s job-loss total was roughly 60,000 higher than the previous month's, prompting a hastily convened powwow between the president, House Speaker Nancy Pelosi, and Senate Majority Leader Harry Reid. (The number has since been revised downward.) Then, in early November, Democratic candidates handily lost gubernatorial elections in New Jersey and Virginia, with independents deserting the party in droves. “For those up next year, it was a wake-up call on the deficit,” says one Senate Democratic aide. Suddenly, spending more money on jobs didn’t look so appetizing. That is, until the following Friday, when the next jobs report showed the unemployment rate jumping from 9.8 percent to 10.2 percent--clearing a psychological threshold that was no less terrifying for being foreseeable. And on and on it went. “The entire town is more schizophrenic than I’ve ever seen,” says one senior administration official. “Everyone cares about jobs, and everyone cares about fiscal discipline. The weight shifts week by week, unemployment report by unemployment report.”
The basic problem is that any additional stimulus adds to the deficit, while deficit reduction steps on a weak economy. And so, Democrats now find themselves having to pull off a balancing act that would seem to defy the laws of economics: taking on both tasks simultaneously. “We’ve got about as difficult an economic play as is possible,” the president observed at his recent jobs summit.
There was, of course, one famous attempt at this feat during the last generation: the Clinton administration’s in early 1993. The decision about whether to rein in the bulging deficit or spend money on the rickety economy divided the incoming Clinton team. But, in retrospect, the challenge was much easier than the one confronting Obama. For one thing, GDP had been growing for almost two years in early 1993, versus only a single quarter today; unemployment was almost three points lower. For another, the deficit was actually far more tractable back then. The end of the cold war promised a peace dividend, and the bill for the baby boomers’ Social Security and Medicare benefits was basically 20 to 25 years away. Today, the entitlement spending boom is right around the corner, we’re surging in Afghanistan, we’ve spent a few hundred billion dollars propping up the financial system, and we already have one pricey stimulus on the books.
The biggest problem facing the Clintonites back in 1993 was arguably political: The bond market assumed the first Democratic president in twelve years would unleash a wave of pent-up spending. Long-term interest rates stayed stubbornly high as a result. Hence the theory, embraced by Clinton adviser Robert Rubin (and another Clinton economic aide named Larry Summers), that a credible plan for deficit reduction could chip away at long-term rates and boost the economy. The Clintonites were gambling, in effect, that deficit reduction could itself be a form of stimulus because of the unique historical moment--that they might not have to choose between the two. Sure enough, interest rates abruptly fell (though inflation did, too), and the '90s boom commenced.
Alas, there’s no such win-win solution this time around--among other things, there’s little room for historically low rates to fall much more--meaning the only way to further stimulate the economy is to spend. “Now is not the time politically or economically to emphasize fiscal austerity,” says Simon Rosenberg, president of NDN, a Washington think tank. “That day will come.”
Rosenberg is surely right about the need to punt for the moment on the deficit. But it turns out that this choice is only the beginning of the discussion, not the end. Worse, it’s a discussion that rapidly degenerates into a giant catch-22. Take, for example, the fact that spending more money now could actually raise long-term rates, thereby offsetting its stimulative effect. “The reality is that it’s not too hard to find a Wall Street analyst that says a second stimulus basically cancels itself out almost immediately because of the impact at this stage on government financing costs,” says one senior administration official.
COMMENTS (9)
Sure sounds like some haven't understood Keynsian economics re budget deficits in a depression/very bad recession-- and/or willing to act consistently and boldly according to that understanding. Sounds like another Obama half-measure. Also sounds like the cost of two unwinable war fronts are never mentioned or considered-- at least by Chait who is presumably properly assessing debates within the administration. Also sounds like there is no von Rundstedt within TNR or the administration who blurts out reality to those who are blind to reality "Make peace you fools"?
Sure sounds like some haven't understood Keynsian economics re budget deficits in a depression/very bad recession-- and/or willing to act consistently and boldly according to that understanding. Sounds like another Obama half-measure. Also sounds like the cost of two unwinable war fronts are never mentioned or considered-- at least by Chait who is presumably properly assessing debates within the administration. Also sounds like there is no von Rundstedt within TNR or the administration who blurts out reality to those who are blind to reality "Make peace you fools"?
Excellent article. Concise and lucid. If I were advising Obama, I'd be inclined to emphasize the political (both direct (popular support) and indirect (confidence in credit markets)) over the economic, especially at this stage in the "recovery". I suppose it depends on one's view of Keynesian economics (public spending): is its primary purpose to upset a high unemployment, low output equilibrium, or to offset lost private sector output.
I would add one complication in the current situation: large-scale public spending outside the US, adding to the deficits but not much to the recovery.
Excellent article. Concise and lucid. If I were advising Obama, I'd be inclined to emphasize the political (both direct (popular support) and indirect (confidence in credit markets)) over the economic, especially at this stage in the "recovery". I suppose it depends on one's view of Keynesian economics (public spending): is its primary purpose to upset a high unemployment, low output equilibrium, or to offset lost private sector output.
I would add one complication in the current situation: large-scale public spending outside the US, adding to the deficits but not much to the recovery.
The recent winter weather has given me a thought that seems apropos to the deficit vs. recession issue. What we have is a classic Keynesian liquidity trap that can be visualized as follows.
My car battery (the economy in aggregate) is only able to output about 2/3 of it's designed electricity when the temperature is very low. The alternator (spending overall) has to be run at high RPM for a considerable length of time in order to replace the lost electrical capacity. The less I run engine and alternator (the deficit/debt reduction), the more the battery drains, particularly as the temperature remains low. The lower the battery is allowed to drain, the less ability it will have to start th ... view full comment
The recent winter weather has given me a thought that seems apropos to the deficit vs. recession issue. What we have is a classic Keynesian liquidity trap that can be visualized as follows.
My car battery (the economy in aggregate) is only able to output about 2/3 of it's designed electricity when the temperature is very low. The alternator (spending overall) has to be run at high RPM for a considerable length of time in order to replace the lost electrical capacity. The less I run engine and alternator (the deficit/debt reduction), the more the battery drains, particularly as the temperature remains low. The lower the battery is allowed to drain, the less ability it will have to start the car in the first place to begin the recharging (recovery) process. It may even be permanently damaged if allowed to stay in a state of discharge through non-use or short-term attempts to overtax it by starting the engine but never allowing it to warm up and fully charge the battery. The battery will never gets fully charged nor can it recover unless the alternator is given enough time to restore its electrical capacity.
Deficit reduction in the short term, particularly in times of high unemployment and soaring health care costs, prevents the economy from getting the "re-charge" it needs to restore it to its original capacity. As a long-term goal, deficit reduction is desirable for the overall health of the economy but during a liquidity trap, it only leads to damage and failure.
Not a perfect analogy, but it may help as a visual tool.
Another, simpler, metaphor might be "When the house is on fire, you don't run down to the bank and pay off the mortgage".
Another, simpler, metaphor might be "When the house is on fire, you don't run down to the bank and pay off the mortgage".
If you want more jobs you have to increase aggregate demand. There are pretty much only 3 sources of demand, private, foreign (i.e. exports), and government. Someone has to spend more. In the case of government, it can spend more or tax less. Either way the only way to increase demand via the government is higher deficits.
So if the Obama administration thinks it's important to reduce government deficits AND unemployment the only option would be to get the private and foreign sectors to spend more. In that case stop encouraging private dollar savings (in the form or IRA's, 401(k)'s and other tax privileged savings accounts).
Personally I think their only priority should be jobs. The defi ... view full comment
If you want more jobs you have to increase aggregate demand. There are pretty much only 3 sources of demand, private, foreign (i.e. exports), and government. Someone has to spend more. In the case of government, it can spend more or tax less. Either way the only way to increase demand via the government is higher deficits.
So if the Obama administration thinks it's important to reduce government deficits AND unemployment the only option would be to get the private and foreign sectors to spend more. In that case stop encouraging private dollar savings (in the form or IRA's, 401(k)'s and other tax privileged savings accounts).
Personally I think their only priority should be jobs. The deficit is a natural consequence of the currency system we use and really isn't any problem. If we had rampant inflation, then maybe it would a good idea to cut the deficit, but I don't see any inflation at the moment.
"Reducing the deficit" has potent magical shimmerings that cannot be ignored. Yet of course Reagan did just that and talked all the time about the horror of deficits while tripling the one he started with. Perhaps this is just smoke-cover for the Obama administration to counterattack the usual broadside against "free-spending Democrats" (a historically bollixed semi-smear if ever there was one). OF COURSE, jobs are more important than the deficit. This has been shown to be true repeatedly (besides morally advisable) in the last 75 years, and all the revisionist economic theory in the world can't make these facts go away. But those shimmerings are kind of nice, aren't they?
"Reducing the deficit" has potent magical shimmerings that cannot be ignored. Yet of course Reagan did just that and talked all the time about the horror of deficits while tripling the one he started with. Perhaps this is just smoke-cover for the Obama administration to counterattack the usual broadside against "free-spending Democrats" (a historically bollixed semi-smear if ever there was one). OF COURSE, jobs are more important than the deficit. This has been shown to be true repeatedly (besides morally advisable) in the last 75 years, and all the revisionist economic theory in the world can't make these facts go away. But those shimmerings are kind of nice, aren't they?
Talk about thinking in the box!! After reading the above comments and, in an earlier edition, Judge Posner's summary of Keynes, it isn't difficult to see why economics is no science. Is inadequate demand the problem, especially after going through several years where there was excessive demand and artificially low short term interest rates to feed that demand? Consumers realize they are over leveraged and have been pulling back from the brink - at least those that didn't go too far. What is the recommendation by people who say they are Keynesians? Apparently, the government should become the substitute for the consumers who have unfortunately come to their senses. That is, the government ... view full comment
Talk about thinking in the box!! After reading the above comments and, in an earlier edition, Judge Posner's summary of Keynes, it isn't difficult to see why economics is no science. Is inadequate demand the problem, especially after going through several years where there was excessive demand and artificially low short term interest rates to feed that demand? Consumers realize they are over leveraged and have been pulling back from the brink - at least those that didn't go too far. What is the recommendation by people who say they are Keynesians? Apparently, the government should become the substitute for the consumers who have unfortunately come to their senses. That is, the government should become the stand-in as the insensible spender. The government should replace declining consumer debt. Here is an out of the box thought: How about considering that total demand should shrink? (Actually the demand is there. Who doesn't want more? The Keynesian isn't really talking about demand; he (or she) is talking about spending and spending alone.)
But the proposed government spending isn't just about pumping money into the economy to replace the decline in individual consumption. It turns out that investors are also coming to their senses. They are measuring the risk / return trade-off. They are thinking before they leap - first time in several years. So the other side of the stimulus bill is that the government becomes a stand-in for suddenly sensible investors. The government is to replace the investor side of the equation. Would you actually give your savings to the government to invest wisely for your future? But I guess that is mainly the problem of future generations - our heirs. Turns out the self-proclaimed Keynesians are a peculiar version of supply siders as well. (Ever look at the use of the stimulus funds in your state? Quite amazing! Amazing but not thoughtful.)
What Keynes and most economists pay little to no attention to are the two most important components of human economic behavior. To cut to the chase, has anyone here ever thought that the best way to get investors back into the US economy is to sharply reduce the cost of doing business? This isn't just taxes (or fees if you prefer); it includes the myriad of growing regulations, virtually all of which have an adverse impact on the cost of doing business. Why do you think our asset values are dropping while Asia's are rising (to the extent there is most certainly a bubble in Asia)? Investors are still around; they are either holding onto their cash or they are investing in what they regard as more attractive countries.
The second component is disposable income, or the other side of the coin, the cost of living. The wealthy and the middle class are going to be hammered on several fronts. The ability of consumers to spend, even if they were so inclined, is going to be reduced significantly through higher taxes, higher prices (e.g., health insurance) and mandatory fees. Demand defined as spending will drop. This is indeed quite a liquidity trap - one that is created by the demand on the part of politicians for yet more programs and regulations of all sorts that we actually can't afford.
The focus right now should be on making the US the most attractive place in the world to invest. We are competing for scarce global capital. Open your eyes and use your imagination! In the meantime, don't take money out of peoples bank accounts at a time when they most need it.
klfoster, this is the basic flaw in your argument: "Apparently, the government should become the substitute for the consumers who have unfortunately come to their senses." That is not correct. The Keynesian theory is to put money into the hands of consumers, by employing them or creating employment opportunities for them, so that they will consume. It is consumption, and the endeavor to meet the demand of consumption, that drives an economy. Consumers have not "come to their senses." They have either maxed out on their credit, lost their jobs, or simply become spooked by the "crisis" and are hoarding rather than spending. Hence the decline in consumption/demand, the decline in product ... view full comment
klfoster, this is the basic flaw in your argument: "Apparently, the government should become the substitute for the consumers who have unfortunately come to their senses." That is not correct. The Keynesian theory is to put money into the hands of consumers, by employing them or creating employment opportunities for them, so that they will consume. It is consumption, and the endeavor to meet the demand of consumption, that drives an economy. Consumers have not "come to their senses." They have either maxed out on their credit, lost their jobs, or simply become spooked by the "crisis" and are hoarding rather than spending. Hence the decline in consumption/demand, the decline in production, the decline in employment, the decline in demand, and so on and so on.
You have to be kidding -- Keynesian Econcomics?
In case you haven't read a serious economics journal / book in last 3 decades -- the two pillars of Keynesian Theory --- IS/LM relationship and Phillips curve -- have been soundly disproved. They don't predict or explain economic reality very welll at all.
Gov't doens't create jobs -- best it can do is take away the penalties that exist for private sector to create jobs -- encourage investment
You have to be kidding -- Keynesian Econcomics?
In case you haven't read a serious economics journal / book in last 3 decades -- the two pillars of Keynesian Theory --- IS/LM relationship and Phillips curve -- have been soundly disproved. They don't predict or explain economic reality very welll at all.
Gov't doens't create jobs -- best it can do is take away the penalties that exist for private sector to create jobs -- encourage investment