President’s austerity plan is the wrong strategy for stimulating the economy

imo-blogMark Thoma found President Obama’s remarks this week on deficit reduction talks with the Republicans disappointing on several fronts: First, that the president seems committed to doing whatever it takes to reach a deal; and second, that Obama has adopted austerity as a valid means of stimulating the economy.

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I found the president’s remarks during his press conference this week on deficit reduction talks with the Republican disappointing on several fronts. First, I am disappointed that the president seems committed to doing whatever it takes to reach a deal. There are lines that ought to be drawn in the sand, but even when they are drawn the lines are erased and moved as needed. It looks like a deal will be reached, the only question at this point seems to be how much the president will give away to get it. The president was, of course, trying to make it look like he is the one willing to compromise so that if a deal is not reached, the consequences will be blamed on Republicans. But it also appears he is willing to move quite a bit to get a deal done.

Second, I am disappointed that Obama has adopted austerity as a valid means of stimulating the economy, something he made absolutely clear during his remarks. There is no evidence that this works in a situation like ours, i.e. that deficit cuts create so much confidence that they stimulate the economy. However, there is plenty of evidence that the fall in demand from the deficit cuts is harmful, and that such cuts are likely to impede the recovery. The president has embraced the idea that uncertainty about the future, particularly worries about the deficit, is holding back the economic recovery even though this cannot be justified from the historical record. It’s hope over experience.

Uncertainly may be a problem, but it’s not uncertainty about the deficit. What’s holding the economy back is uncertainty about jobs, worries about the slowing recovery, and whether a second recession is coming. The policy the president wants, deficit reduction as large and as soon as possible, is likely to make the prospects for recovery even worse and increase uncertainty. The president claims that the “single biggest boost to business certainty and confidence” would be to cut the deficit, but I think confidence depends much more upon the state of the economy. Evidence of growth and employment increases are what is needed, and until that happens businesses are going to remain cautious. Taking actions that make the economy worse right now is the wrong way to proceed, the drag on GDP growth that deficit reduction causes will have a larger impact on confidence than deficit reduction.

One thing the president said — the third disappointment — was particularly worrisome. He said we shouldn’t be concerned about “job killing tax increases” because there won’t be any tax increases until 2013 when the economy should be in better shape. Thus, he has adopted the Republican argument that we cannot raise taxes when the job picture is so bad. But how does that square with the phrase he uttered repeatedly, “if not now, when?” And more importantly, how does that square with the desire to cut spending? Why is he willing to implement spending cuts immediately but not tax increases? There is evidence that spending cuts have at least as large a negative effect on employment as tax increases, and the impact is likely larger. If the “if not now, when” applies to spending cuts, why not taxes? If the argument that we can’t do “job killing tax increases” now, why is it okay to do job killing spending cuts? If the president is willing to go along with a delay in tax increases over worry about the economy, he ought to also be insist on delaying the spending cuts in the same way.

In the Q&A section he did say that we need job creation programs, an infrastructure program for example, and other steps to create jobs, but politics won’t allow this. What I find disappointing about this is that if the president approached this issue with the same tenacity as he has approached deficit reduction, then perhaps it wouldn’t look so impossible. In any case, he certainly shouldn’t embrace deficit reduction — the exact opposite of what he admits is needed in the short-run — as an alternative to short-run stimulus.

We need to get out long-run deficit under control, and as the president says, this is a great chance to make progress on this issue. But we shouldn’t take a chance of harming the economy when it remains so weak. If we can delay tax changes until the economy is on better footing, then we can also delay spending cuts. We need to set a plan now for tax increases and spending cuts, one that kicks in, say, when the unemployment rate falls below a fixed threshold. That makes inroads on the long-term debt and allows business confidence to increase as desired without risking the recovery (though, as noted above, I don’t think this is the main factor in business confidence, that has more to do with the economic outlook).

One worry is the credibility of future promises. How will we know if the plan will actually be executed? One answer is that if promises about future tax increases are credible, and the president and Congress seem to think they are, then so should promises of future cuts. Another, perhaps better answer is that if the public and businesses are as worried about this as the president says, once the plan is in place the president can use his bully pulpit to dare politicians to alter the plan (and promise to veto any changes). By making the future commitments very clear, any politician who tries to deviate ought to pay a large political price.

In the short-run, we need to boost the economy, or at least not make things worse through premature deficit reduction or interest rate increases by the Fed. In the longer-run, we need a plan to get the deficit under control, particularly the largest driver of future deficit fears, the growth in health care costs. Unfortunately, that is not where we appear to be headed, and I am very worried that large spending cuts now in return for a promise of future tax increases will harm the recovery and create even more misery for those trying to find jobs.

Thus, with the best plan ruled out — stimulus now, deficit reduction in the future — we are left with the lesser of two evils. Give in to the job and economy killing spending cuts the Republicans are demanding and the president appears to have embraced, or risk doing even more damage by failing to come to an agreement and defaulting on the debt. Our choices should not be limited to those options, and the fact that they are is yet another reason to be disappointed in the outcome of the talks. The president should have fought for a third option, he has the ability to change the political reality instead of just throwing up his hands and saying this is the best he can do, and those who are the most vulnerable, the unemployed, those relying on programs that will be cut, etc. will pay the largest cost.

Mark Thoma is a professor of economics at the University of Oregon.

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