1) The document discusses concerns about excessive fiscal tightening hindering economic recovery from financial crises which typically involve long recovery periods as balance sheets are repaired.
2) It notes that past recessions associated with financial crises saw policy tightened too soon, slowing recovery, and that increased taxes and government spending cuts have recently shaved US GDP growth and job levels.
3) While deficit reduction is important long-term, the document argues that short-term austerity measures are "bad economics" and risk derailing economic recovery.
Senior Fed officials meet next week amid what is widely seen as a slow patch in economic growth. A key question for investors, as well as for monetary policymakers, is whether this slowing will be temporary. Most likely, growth should pick up in the second half of the year. However, there are downside risks in the near term. Moreover, monetary policy appears to be handcuffed and fiscal policy is set to go in the wrong direction.
High levels of government debt are a big concern for investors both here and abroad. Efforts must be made eventually to reduce deficits. However, acting too soon will weaken the economic recovery. Looking ahead, there are no easy solutions.
The first part of December is a busy time for economists. People want to know what’s going to happen in the coming year. However, nobody’s clairvoyant. Forecasts are certain to be wrong. We can only tell you what to expect. The outlook for 2011 has been especially challenging, as the ground has been shifting under our feet. The tax proposal, the rout in bonds, and simmering concerns about Europe would seem to have significant impacts on the growth outlook, and they do. However, as with any economic recovery, positive forces battle it out with negative forces, with the positive force eventually dominating. Along the way, the pace is typically uneven across time and across sectors. That implies some volatility in the markets as investors debate the strength of the recovery.
Two clouds hung over the financial markets in the late summer: worries about a European financial crisis and concerns that the U.S. economy might be tipping back into recession. Real GDP rose at a 2.5% annual rate in the advance estimate for 3Q11, which should put to rest fears that the U.S. economy has already entered recession. However, there are still some important uncertainties in the growth outlook for 2012. European leaders dodged a bullet last week, with the agreement on Greek debt (failure would have triggered a more immediate crisis). However, they did not put a number of problems to bed completely. So, how long will the good feelings last?
Last week, the federal government breached the current debt ceiling, $14.284 trillion. The Treasury had begun taking evasive action the week before, but warned that it couldn’t do so beyond early August – and Congress would have to raise the debt ceiling before then. Will the government default? The strong betting is that it won’t. The bond market doesn’t seem to be worried. However, the increased rhetoric could have a bigger impact on the equity and currency markets.
What is the "fiscal cliff"? It's the term being used by many to describe the unique combination of tax increases and spending cuts scheduled to go into effect on January 1, 2013. The ominous term reflects the belief by some that, taken together, higher taxes and decreased spending at the levels prescribed have the potential to derail the economy. Whether we do indeed step off the cliff at the end of the year, and what exactly that will mean for the economy, depends on several factors.
One of the key themes for investors in early 2011 is likely to be a shifting economic picture. For the stock market, things tend to be all or none. That is, either the economy is booming or it’s falling apart – there’s not much ground in the middle. Investors seem to struggle with moderate and uneven economic growth. The tax cut package has taken the double-dip recession scenario off the table, but the data for the next few months are likely to be mixed, suggesting strong growth in one set of figures and more moderate growth in another. That back and forth should create some opportunities for investors.
Senior Fed officials meet next week amid what is widely seen as a slow patch in economic growth. A key question for investors, as well as for monetary policymakers, is whether this slowing will be temporary. Most likely, growth should pick up in the second half of the year. However, there are downside risks in the near term. Moreover, monetary policy appears to be handcuffed and fiscal policy is set to go in the wrong direction.
High levels of government debt are a big concern for investors both here and abroad. Efforts must be made eventually to reduce deficits. However, acting too soon will weaken the economic recovery. Looking ahead, there are no easy solutions.
The first part of December is a busy time for economists. People want to know what’s going to happen in the coming year. However, nobody’s clairvoyant. Forecasts are certain to be wrong. We can only tell you what to expect. The outlook for 2011 has been especially challenging, as the ground has been shifting under our feet. The tax proposal, the rout in bonds, and simmering concerns about Europe would seem to have significant impacts on the growth outlook, and they do. However, as with any economic recovery, positive forces battle it out with negative forces, with the positive force eventually dominating. Along the way, the pace is typically uneven across time and across sectors. That implies some volatility in the markets as investors debate the strength of the recovery.
Two clouds hung over the financial markets in the late summer: worries about a European financial crisis and concerns that the U.S. economy might be tipping back into recession. Real GDP rose at a 2.5% annual rate in the advance estimate for 3Q11, which should put to rest fears that the U.S. economy has already entered recession. However, there are still some important uncertainties in the growth outlook for 2012. European leaders dodged a bullet last week, with the agreement on Greek debt (failure would have triggered a more immediate crisis). However, they did not put a number of problems to bed completely. So, how long will the good feelings last?
Last week, the federal government breached the current debt ceiling, $14.284 trillion. The Treasury had begun taking evasive action the week before, but warned that it couldn’t do so beyond early August – and Congress would have to raise the debt ceiling before then. Will the government default? The strong betting is that it won’t. The bond market doesn’t seem to be worried. However, the increased rhetoric could have a bigger impact on the equity and currency markets.
What is the "fiscal cliff"? It's the term being used by many to describe the unique combination of tax increases and spending cuts scheduled to go into effect on January 1, 2013. The ominous term reflects the belief by some that, taken together, higher taxes and decreased spending at the levels prescribed have the potential to derail the economy. Whether we do indeed step off the cliff at the end of the year, and what exactly that will mean for the economy, depends on several factors.
One of the key themes for investors in early 2011 is likely to be a shifting economic picture. For the stock market, things tend to be all or none. That is, either the economy is booming or it’s falling apart – there’s not much ground in the middle. Investors seem to struggle with moderate and uneven economic growth. The tax cut package has taken the double-dip recession scenario off the table, but the data for the next few months are likely to be mixed, suggesting strong growth in one set of figures and more moderate growth in another. That back and forth should create some opportunities for investors.
The recent data have been mixed, consistent with a slower rate of economic growth in the near term. The economy faced a number of headwinds in the first half of the year. Some of those headwinds are likely to be temporary. Others will linger. Growth should pick up in the second half of the year, but the pace seems unlikely to be especially strong
The Federal Open Market Committee, the Fed’s policymaking arm, will meet on November 2-3. Clearly, there are some differences of opinion among senior Fed officials regarding the appropriate path for monetary policy. However, the dissenters (those wanting to do less) are a small minority. The FOMC will come together with a somewhat less troublesome near-term economic outlook (no recession in the near term), but there are more concerns about growth in 2012.
The recent economic data have been disappointing, but hardly a disaster. The broad range of indicators suggest a slowing in the pace of growth – not a contraction. One month does not a trend make, but the data have generated some anxieties about whether the current slow patch could be a lot longer lasting or turn into something more severe.
In the last few months, some have taken to calling the current economic period, “the Lesser Depression” (instead of “the Great Recession”). There’s no precise definition of “a depression” (and as it is, the definition of “a recession” is rather vague). Most economists would say a depression is a lengthy period of elevated unemployment. That’s exactly what we may be staring out now. Monetary and fiscal policy could provide further support for growth, but there’s a lot of resistance.
Research on past recessions shows that downturns that are caused by financial crises tend to be more severe, longer lasting, and with more gradual recoveries than a typical recession. The current recovery is playing out largely as anticipated. The economy is improving, although the labor market remains weak. That should be no surprise to anyone.
The debt ceiling crisis heated up last week, as Moody’s and Standard & Poor’s threatened to lower the credit rating on U.S. debt. The financial markets appeared not to notice or to care, but may simply be expressing a confidence that the debt ceiling will be raised in time. After all, we’ve been here before. As dysfunctional as Washington is, lawmakers aren’t foolish enough to cause a self-inflicted financial calamity. Or are they?
The recent economic data have been generally weaker than expected, casting some doubt on the prospects for the recovery. However, economic recoveries are not usually associated with steady growth across sectors. Growth is inherently uneven. That means that some economic reports will be strong and some weak – and that is especially true in the current environment, where the economy has to deal with a number of serious headwinds. Economic statistics are also subject to seasonal adjustment difficulties and, as we’re likely to see in much of the February data, the peculiarities of the weather. Bad February weather will not cause a double dip, but it may add to the unease in the financial markets in the near term.
Inflation Expectations, Budget DecisionsJeff Green
On the surface, the February Employment Report was strong, but the details suggest more moderate improvement in the labor market. Still, new hiring is likely to pick up in the spring. Higher oil prices threaten the outlook for jobs and the overall economy. The Fed appears to be in a tough spot, but should keep monetary policy accommodative for some time.
The advance figure for fourth quarter growth surprised to the upside, although the story was largely as anticipated. The GDP data will be revised at the end of February and again in late March (and in perpetuity, in annual benchmark revisions). Don’t get too wedded to the numbers. However, the story is unlikely to change much in revision.
In the coming months and years, lawmakers will face a number of important budget-related deadlines, or Fiscal Speed Bumps, that will require legislative action. These Fiscal Speed Bumps will present challenges, risks, and opportunities. Addressed irresponsibly, they could cause serious disruptions and/or add as much as $3 trillion to the debt over the next decade above what current law would allow. But if dealt with thoughtfully, they offer an opportunity to pursue reforms that would grow the economy, improve the policy landscape, and reduce the risk of an uncontrollably growing national debt.
Later this month, Fed Chairman Bernanke will hold his first post-FOMC meeting press conference. Officially, the press conference is meant “to present the Federal Open Market Committee's current economic projections and to provide additional context for the FOMC's policy decisions.” However, the real goal is to reclaim the narrative. The Fed was caught off guard by the amount of criticism and second-guessing it received in 2010. Fed Chairman Bernanke tried hard to counter that, appearing on 60 Minutes, speaking to trade groups, and so on. These press conferences should help clear things up regarding monetary policy – not that we’ll receive clear signals of future Fed policy moves – rather, we’ll get important information on how the Fed will decide what to do.
Later this month, the government will release the advance estimate of 3Q11 GDP growth. There are uncertainties in that estimate – inventories and foreign trade make up a relatively small part of the economy, but account for much of the quarterly variation in GDP growth. We already have a good idea regarding the “meat and potatoes” of that report. Consumer spending and business fixed investment expanded further in the third quarter, suggesting no recession in the near term. However, the economic outlook for 2012 is a lot less clear.
Financial institutions face both domestic and international regulatory uncertainty. Learn what we think you should prepare for in 2017 and how EAI can help.
Nonfarm payrolls fell by 36,000 in the advance estimate for February, and would have likely been positive if not for the weather. It’s impossible to estimate precisely the impact that the snowstorms had on payrolls and average weekly hours, but we should see a rebound in the March employment figures. Hiring for the 2010 census is underway, and is expected to peak in May. Unfortunately, those temporary census jobs will be shed in June and the months that follow. Still, looking beyond the impact of the census, job growth is nearly here.
It’s well known that recessions that are caused by financial crises are much more severe, are longer lasting, and are followed by gradual recoveries. Another lesson from history is that during these recoveries, policies are often tightened too soon. In 1937, efforts to balance the budget led to a recession within the Great Depression. It’s said that those who don’t remember the past are doomed to repeat it.
Higher oil prices have raised new concerns about the strength of the economic recovery. If sustained, the rise in gasoline prices will restrain the pace of economic growth noticeably, but does not appear to be large enough (so far) to derail the expansion. Meanwhile, a federal government shutdown looms as lawmakers bicker over the future path of expenditures. Austerity at all levels of government is well-intentioned, but is not advisable at this point in the economic recovery.
The recent data have been mixed, consistent with a slower rate of economic growth in the near term. The economy faced a number of headwinds in the first half of the year. Some of those headwinds are likely to be temporary. Others will linger. Growth should pick up in the second half of the year, but the pace seems unlikely to be especially strong
The Federal Open Market Committee, the Fed’s policymaking arm, will meet on November 2-3. Clearly, there are some differences of opinion among senior Fed officials regarding the appropriate path for monetary policy. However, the dissenters (those wanting to do less) are a small minority. The FOMC will come together with a somewhat less troublesome near-term economic outlook (no recession in the near term), but there are more concerns about growth in 2012.
The recent economic data have been disappointing, but hardly a disaster. The broad range of indicators suggest a slowing in the pace of growth – not a contraction. One month does not a trend make, but the data have generated some anxieties about whether the current slow patch could be a lot longer lasting or turn into something more severe.
In the last few months, some have taken to calling the current economic period, “the Lesser Depression” (instead of “the Great Recession”). There’s no precise definition of “a depression” (and as it is, the definition of “a recession” is rather vague). Most economists would say a depression is a lengthy period of elevated unemployment. That’s exactly what we may be staring out now. Monetary and fiscal policy could provide further support for growth, but there’s a lot of resistance.
Research on past recessions shows that downturns that are caused by financial crises tend to be more severe, longer lasting, and with more gradual recoveries than a typical recession. The current recovery is playing out largely as anticipated. The economy is improving, although the labor market remains weak. That should be no surprise to anyone.
The debt ceiling crisis heated up last week, as Moody’s and Standard & Poor’s threatened to lower the credit rating on U.S. debt. The financial markets appeared not to notice or to care, but may simply be expressing a confidence that the debt ceiling will be raised in time. After all, we’ve been here before. As dysfunctional as Washington is, lawmakers aren’t foolish enough to cause a self-inflicted financial calamity. Or are they?
The recent economic data have been generally weaker than expected, casting some doubt on the prospects for the recovery. However, economic recoveries are not usually associated with steady growth across sectors. Growth is inherently uneven. That means that some economic reports will be strong and some weak – and that is especially true in the current environment, where the economy has to deal with a number of serious headwinds. Economic statistics are also subject to seasonal adjustment difficulties and, as we’re likely to see in much of the February data, the peculiarities of the weather. Bad February weather will not cause a double dip, but it may add to the unease in the financial markets in the near term.
Inflation Expectations, Budget DecisionsJeff Green
On the surface, the February Employment Report was strong, but the details suggest more moderate improvement in the labor market. Still, new hiring is likely to pick up in the spring. Higher oil prices threaten the outlook for jobs and the overall economy. The Fed appears to be in a tough spot, but should keep monetary policy accommodative for some time.
The advance figure for fourth quarter growth surprised to the upside, although the story was largely as anticipated. The GDP data will be revised at the end of February and again in late March (and in perpetuity, in annual benchmark revisions). Don’t get too wedded to the numbers. However, the story is unlikely to change much in revision.
In the coming months and years, lawmakers will face a number of important budget-related deadlines, or Fiscal Speed Bumps, that will require legislative action. These Fiscal Speed Bumps will present challenges, risks, and opportunities. Addressed irresponsibly, they could cause serious disruptions and/or add as much as $3 trillion to the debt over the next decade above what current law would allow. But if dealt with thoughtfully, they offer an opportunity to pursue reforms that would grow the economy, improve the policy landscape, and reduce the risk of an uncontrollably growing national debt.
Later this month, Fed Chairman Bernanke will hold his first post-FOMC meeting press conference. Officially, the press conference is meant “to present the Federal Open Market Committee's current economic projections and to provide additional context for the FOMC's policy decisions.” However, the real goal is to reclaim the narrative. The Fed was caught off guard by the amount of criticism and second-guessing it received in 2010. Fed Chairman Bernanke tried hard to counter that, appearing on 60 Minutes, speaking to trade groups, and so on. These press conferences should help clear things up regarding monetary policy – not that we’ll receive clear signals of future Fed policy moves – rather, we’ll get important information on how the Fed will decide what to do.
Later this month, the government will release the advance estimate of 3Q11 GDP growth. There are uncertainties in that estimate – inventories and foreign trade make up a relatively small part of the economy, but account for much of the quarterly variation in GDP growth. We already have a good idea regarding the “meat and potatoes” of that report. Consumer spending and business fixed investment expanded further in the third quarter, suggesting no recession in the near term. However, the economic outlook for 2012 is a lot less clear.
Financial institutions face both domestic and international regulatory uncertainty. Learn what we think you should prepare for in 2017 and how EAI can help.
Nonfarm payrolls fell by 36,000 in the advance estimate for February, and would have likely been positive if not for the weather. It’s impossible to estimate precisely the impact that the snowstorms had on payrolls and average weekly hours, but we should see a rebound in the March employment figures. Hiring for the 2010 census is underway, and is expected to peak in May. Unfortunately, those temporary census jobs will be shed in June and the months that follow. Still, looking beyond the impact of the census, job growth is nearly here.
It’s well known that recessions that are caused by financial crises are much more severe, are longer lasting, and are followed by gradual recoveries. Another lesson from history is that during these recoveries, policies are often tightened too soon. In 1937, efforts to balance the budget led to a recession within the Great Depression. It’s said that those who don’t remember the past are doomed to repeat it.
Higher oil prices have raised new concerns about the strength of the economic recovery. If sustained, the rise in gasoline prices will restrain the pace of economic growth noticeably, but does not appear to be large enough (so far) to derail the expansion. Meanwhile, a federal government shutdown looms as lawmakers bicker over the future path of expenditures. Austerity at all levels of government is well-intentioned, but is not advisable at this point in the economic recovery.
Faster than a speeding tortoise, more powerful than suntan lotion, unable to leap small objects in a single bound – the Joint Select Committee on Deficit Reduction (aka “the super committee”) is stumbling toward its November 23 deadline.
A year ago, in a sharply weakening economy, deflation seemed a credible threat. However, a rebound in energy prices has boosted the Consumer Price Index over the last 12 months. Improvement in the global economy has led to a firming in commodity prices. Despite the diminished threat of deflation, core inflation at the consumer level has trended lower, thanks in large part to weakness in rents (a consequence of residential housing troubles).
Loan growth plays a key role in economic expansion. Simply put: no loan growth, no economic growth. However, there’s a downside. Debt doesn’t matter until it does. Debt has played a key part in the economic downturn and in the gradual recovery. Europe’s sovereign debt crisis has continued to escalate, with no easy way out. In the U.S., the government has borrowed more, but the markets have not punished it for doing so. There’s no sign that that is going to change anytime soon.
Is there a fate worse than debt? If there is, it seems to be not dealing with the debt. When there is too much leverage in the system, there is always a risk that things go wrong quickly and unexpectedly. Ken Rogoff and Carmen Reinhart have an op-ed piece on Bloomberg today about the debt overhang and its implications for economic growth. They are among the few commentators who have been consistently correct about the path of the financial crisis, probably because they are among the few who have studied the actual data.
The Federal Open Market Committee will meet on Tuesday to set monetary policy. The Fed is widely expected to leave short-term interest rates unchanged and the wording of the economic assessment should be largely the same as in the previous statement. However, we could see another round of asset purchases or some changes to the Fed’s communications.
August Jobs Report- No Sign of a Double DipJeff Green
As with most of the recent data reports, the August Employment report was consistent with a near-term slow patch in economic growth, but not a double dip. Private-sector growth in nonfarm payrolls remained positive, and figures for the previous two months were revised higher. However, while the job numbers were better than expected, the pace is nowhere near where we’d like it to be.
The November Employment Report was disappointing. The stock market had set its sights high, anticipating stronger growth in nonfarm payrolls and a steady unemployment rate. Moreover, market participants seemed to be hoping for an upside surprise relative to the consensus forecast. The holiday shopping season apparently got off to a strong start, but that failed to translate into a corresponding jump in retail employment (at least, on a seasonally adjusted basis). Manufacturing jobs were soft. State and local government continued to shed jobs, reflecting budget strains. What’s in store for 2011? The November jobs data aren’t encouraging, but the recovery is likely to remain on track.
The June Employment Report was disappointing. Nonfarm payrolls rose less than expected. Figures for April and May were revised lower. Average weekly hours declined. Temp-help employment fell. There were no bright spots. That doesn’t mean that the economy won’t recover in the second half, but headwinds will prevent growth from being a lot stronger.
The Economic Outlook – In A Holding PatternJeff Green
Recent economic figures have been consistent with the view of lackluster-to-moderate growth in the near term – not a recession, although the risk of a renewed downturn remains. Whether the U.S. slips back into recession depends on a number of factors: gasoline prices, developments in Europe, and policies that may or may not come out of Washington, D.C.
After all the debate in recent weeks over issues related to raising the nation's debt limit, it's hard to know exactly what might happen after August 2. Borrowing represents more than 40% of the nation's expenses, and any default on the country's obligations would be unprecedented.
Commodity prices have moved sharply higher over the last several months, leading to increased worries that the Fed is “behind the curve,” “debasing the currency,” or “monetizing the debt.” Such fears are based on a poor understanding of the inflation process and how the Fed conducts monetary policy.
Commodity prices have moved sharply higher over the last several months, leading to increased worries that the Fed is “behind the curve,” “debasing the currency,” or “monetizing the debt.” Such fears are based on a poor understanding of the inflation process and how the Fed conducts monetary policy.
Commodity prices have moved sharply higher over the last several months, leading to increased worries that the Fed is “behind the curve,” “debasing the currency,” or “monetizing the debt.” Such fears are based on a poor understanding of the inflation process and how the Fed conducts monetary policy.
The American Taxpayer Relief Act of 2012Jeff Green
The new year began with some political drama, as last-minute negotiations attempted to avert sending the nation over the "fiscal cliff." Technically, we actually did go over the cliff, however briefly, as a host of tax provisions and automatic spending cuts took effect at the stroke of midnight on December 31, 2012.
Time Running Out for Large Gifts in 2012Jeff Green
Currently, the exemptions for federal gift tax, estate tax, and generation-skipping transfer (GST) tax are at historic highs, and the gift, estate, and GST tax rates are at historic lows. But, in 2013, the exemptions are scheduled to substantially decrease, and the tax rates are scheduled to substantially increase. This raises the question of whether 2012 might be a good time to make large gifts that take advantage of the current large exemptions while they are still available.
What Does the Supreme Court Ruling on the Health-Care Reform Law Mean for You?Jeff Green
On June 28, 2012, the U.S. Supreme Court ruled, in a landmark decision, that the Patient Protection and Affordable Care Act (ACA), including the provision that most Americans carry health insurance or pay a penalty, is constitutional.
It's no secret that what's happening in Europe is driving financial markets worldwide. Even if you have a sound asset allocation strategy and a well-diversified portfolio, it's hard to ignore the fact that this summer seems to have the potential for turbulence. Markets dislike uncertainty, and at this point uncertainty is high, particularly in advance of the June 17 elections scheduled in Greece.
The S&P 500 (SPX) has tested 1366 on the upside twice, and not had any success even hanging around this level, as it’s been pushed down quickly both times. This doesn’t bode well for an upside resolution in the near term, but it’s certainly a possibility.
Background
As 401(k) plans have become more popular, plan participants have become increasingly responsible for making their own retirement savings decisions. The Department of Labor (DOL) has become concerned that participants in self-directed 401(k) plans (those that allow participants to direct the investment of their own accounts) might not have access to, or might not be considering, information critical to making informed decisions about the management of their accounts--particularly information on investment choices, fees, and expenses.
A positive sign that has come as a result of the back and forth action in the markets over the past couple of weeks is the emergence of a triangle pattern in the S&P 500 (SPX). A triangle pattern, in and of itself, is neither a bullish pattern nor a bearish pattern until the pattern has completed.
At this time last year, income tax planning was particularly challenging. Several tax deductions had already expired, and significant changes, including new, higher income tax rates, were scheduled to take effect at the end of the year. Legislation passed in mid-December, however, hit the "reset" button, reinstituting already-expired deductions, and extending major tax provisions--including lower rates--for an additional one to two years.
The Fed Outlook: Uncertainty and ReluctanceJeff Green
The Federal Open Market Committee policy statement and Chairman Bernanke’s post-meeting press conference held few surprises. Monetary policy is still accommodative – and still on hold. There’s also apparently little will at the Fed to do more to help the recovery along. Fortunately for the Fed and the consumer, we can catch a break if oil prices continue to decline.
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Weekly Commentary by Dr. Scott Brown
Excessive Fiscal Tightening – A Major Worry
June 21 – June 25, 2010
Studies of past recessions show that downturns associated with financial crises tend to be more severe and longer-lasting, with gradual recoveries.
Simply put, it takes a long time to repair financial damage. The restoration of household, business, and banking balance sheets does not happen
overnight. Studies also point to a common error made in these recoveries – that is, policy is often tightened too soon. Chairman Bernanke is a student of
the Great Depression – so the Federal Reserve seems unlikely to make that mistake. However, there is a growing public mood to do “something” about
the federal budget deficit. State and local governments do not have the luxury of borrowing. Increased taxes and cuts in government services have
shaved a few percentage points off GDP growth in recent quarters and reduced nonfarm payrolls. In Europe, austerity has spread beyond the “problem”
countries and fiscal contractions are poised to weaken the recovery in 2011. While well intentioned, excessive fiscal tightening is bad economics.
In the U.S., there have been efforts over the years to enact legislation to require a balanced budget. At its worst, a hard budget balance would be
countercyclical, making recessions worse and booms more frothy. In a downturn, tax revenues normally fall, pushing the budget out of balance. To
return to balance, the government could raise taxes or cut spending, but these moves dampen growth even more. A balanced budget requirement could
be nullified during recessionary periods or in times of war, but that’s not as clear as it sounds. (For example, would Congress have to officially declare
war? What do we mean by a recessionary period?). It may make sense to work toward a balanced budget (or perhaps a small deficit) over the course of
the business cycle, running surpluses during booms and deficits during busts. That sounds easy, but there’s always a strong political incentive to spend
more or to cut taxes during an economic boom. That’s seen clearly at the state level.
2. Most state and local governments have stringent balanced budget requirements. States and cities are responding to the drop in tax revenues by raising
taxes, but mostly by cutting services. In most downturns, government provides some stability. However, in the current recession/recovery, state and
local governments have added to the downturn. Over the 12 months ending in May, state and local governments shed 172,000 payroll jobs (-0.9%).
State and local government subtracted 0.3% from GDP in 4Q09 and 0.5% in 1Q10.
The concept of Keynesian economics has been corrupted over the years by both the right and the left. In the 1960s, it was thought that fiscal policy
could be used to fine-tune the economy. We know now that this is impossible. Similarly, some have argued that any increase in deficit spending would
crowd out private borrowing and be countered by expectations of higher taxes in the year ahead. In general, that’s also wrong. What Keynesian
economics gives you is a recipe for countering a severe recession or depression. It’s not a magic bullet – strong growth will not return overnight.
However, it can prevent the downturn from becoming a lot worse. It’s not a permanent fix. Ultimately, economic growth must depend on the private
sector. However, it allows the private sector time to recover – and to date, that transition is playing out largely as expected.
The nearly $800 billion federal fiscal stimulus was made up of temporary tax cuts and increases in government spending. In the current environment tax
cuts do not give a lot of bang for the buck. That is, for each $1 of tax cuts in this kind of situation, you can expect less than a $1 of additional GDP
growth. That’s because tax cuts are more likely to be saved than spent. Last year’s stimulus checks to senior citizens were a waste. In contrast, $1 spent
on additional government spending (think of hiring someone to build a road or bridge) generates more than $1 in added GDP (since that person spends
most of his pay, which is someone else’s income, and so on). Private-sector estimates show that the stimulus has played an important part in supporting
economic growth in recent quarters. Some of the stimulus was carved out to extensions of unemployment benefits and aid to the states. Neither of these
provides much lift for overall economic growth, but they did prevent the downturn from becoming much more severe.
Still, deficit spending should not be taken lightly. It’s something you would want to do only rarely. There will be some added costs over the long term,
but these are very small – we’re talking a couple of tenths of a percent of GDP – and long-term interest rates remain relatively low (moreover, the sizes
of the government’s Treasury auctions are trending lower).
One major problem with the current deficit spending is that we already had a large structural deficit before the financial crisis. As the economy recovers
and temporary spending fades, the deficit will decline, but we’ll still be left with the structural deficit. The budget outlook 10 to 20 years down the road
is much more troublesome – and Medicare (not Social Security or discretionary government spending) is the major problem.
One issue in deficit spending is deciding how much is enough to carry us through. Removing fiscal stimulus too soon risks derailing the recovery. Anti-
deficit sentiment has already hampered a push for further stimulus to support job growth. Across the Atlantic, austerity moves threaten to dampen
European economic growth in 2011. Long term, deficit reduction is important, but short term, it’s just foolish.