Don't cut the deficit now, but commit to doing it soon
Here’s a very nice column in the New York Times by the only-very-recently-former Council of Economic Advisers Chair, Christina Romer. The Times gave it the headline: “Now Isn’t the Time to Cut the Deficit”–emphasizing this part of Christina’s message:
Now is not the time. Unemployment is still near 10 percent in the United States and in Europe. Tax cuts and spending increases stimulate demand and raise output and employment; tax increases and spending cuts have the opposite effect. This is a basic message of macroeconomics and a central feature of public- and private-sector forecasting models. Immediate moves to lower the deficit substantially would likely result in a 1937-like “double dip” as we struggle to recover from the Great Recession.
Some advocates of austerity argue that, contrary to the conventional view, fiscal tightening now would lower long-term interest rates and improve confidence so much that the impact could be positive. But an ambitious new study in the World Economic Outlook of the International Monetary Fund confirms that fiscal consolidations — that is, deliberate deficit reductions — typically reduce growth substantially…
Taking budget actions now that would further increase unemployment would be not only cruel, but also short-sighted. The longer unemployment remains high, the more likely it is to become permanent as workers’ skills deteriorate and they gradually drop out of the labor force.
Such a situation would be terrible for both the affected workers and the long-run budget situation. Imagine a patient with a slow-growing tumor who is also recovering from pneumonia. The outcome is likely to be worse if the patient is not given time to recover before undergoing surgery.
But I add to the headline based on this part of Christina’s column (emphasis added):
WHILE immediate fiscal tightening isn’t wise for the United States, we do need to address the deficit. The best thing would be for Congress to pass a plan now that will reduce deficits when the economy is back to normal. France’s recent plan to gradually raise its retirement age to 62 from 60 is a classic example of such “backloaded” reduction. President Obama’s proposal to eliminate the Bush tax cuts on high incomes is another: it would raise revenue by only $30 billion in 2011, but by more than $600 billion over the next decade.
History shows that well-designed backloaded plans are credible. For example, changes to Social Security eligibility and taxes have been passed years, if not decades, before they took effect. And in an environment like today’s, when Congress has again agreed to pay-as-you-go rules, deviating from planned reforms forces countervailing actions.
Such backloaded deficit reduction would not hurt growth in the short run — and could raise it. If uncertainty about future budget policy is harming confidence, as some business leaders suggest, spelling out future spending and tax changes could be helpful. More important, showing that policy makers can come together and make essential decisions about our fiscal challenges would reassure all Americans that our economic future is better than the current grim reality.
That’s the key: don’t reduce Social Security benefits or raise taxes today, but give Americans the courage, and the rest of the world’s investors the faith, that we can commit to a plan that is full of hard, not-so-pleasant policy changes, but gets us on a sustainable path no sooner than our economy can handle it–but not much later either.
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