The Washington Post
By: Neil Irwin
December 6, 2010
Spend now. Commit to saving later, and show exactly how you'll do it. That, in a nutshell, is the approach to the federal budget preferred by a wide consensus of centrist economists, but the strategy has garnered little enthusiasm on Capitol Hill.
The tentative agreement reached by the Obama administration and congressional leaders Monday accomplishes the first part of the equation, of using near-term tax cuts and spending to try to boost growth. It would extend Bush-era tax cuts for two more years and unemployment insurance benefits for one year, as well as temporarily reduce the payroll tax. Now the question is how, when, and whether the government will arrive at a plan for the second part, of reducing the deficit over the coming years.
The economic recovery remains fragile and the unemployment rate sky-high at 9.8 percent - arguments for keeping the federal spigot open and taxes low. The U.S. government can borrow money for a decade at about 3 percent, very low by any historical or international standard. That gives policymakers the luxury of being able to keep running large budget deficits for at least the immediate future.
But how much longer this approach could be sustained is impossible to know. Financial markets may have great confidence at the moment in the ability of the United States to pay its debt, but history teaches that financial markets are fickle and crisis can emerge with little warning.
And the eventual need to deal with the deficit - and uncertainty about how - may even be a factor in making businesses cautious about spending the vast sums of cash sitting on their balance sheets. After all, why build a new factory or hire new workers when the government's finances seem to be on an unsustainable track?
The most prominent advocate of keeping a stimulative tax-and-spending policy in place for the time being while also sculpting a plan to bring the deficit down over the next few years is Federal Reserve Chairman Ben S. Bernanke. "We don't want to take actions this year that will affect this year's spending and this year's taxes in a way that will hurt the recovery," Bernanke said in an interview broadcast Sunday on "60 Minutes." "That's important. But that doesn't stop us from thinking now about the long term structural budget deficit."
The fiscal crisis sweeping Europe, in which Ireland and Greece have already needed bailouts and Portugal, Spain, and Italy could come next, offers the United States a brutal lesson. By the time the bond market turns on a country - when investors demand higher interest rates or refuse to roll over debt at any price - policymakers have no good options left.
When that day arrives, a government has little choice but to slash budgets or raise taxes if it wants to satisfy financial markets. But those actions make an already miserable economic situation worse and tend to be vastly unpopular, costing politicians their jobs. Just ask the Irish, who are in such a cycle now.
In other words, when a budget is tightened in response to an immediate crisis of confidence on financial markets, the cuts are almost done quickly and painfully, whereas a plan constructed in advance and executed gradually can dull the pain.
"We've seen in other countries that rushing to play catch-up to reassure credit markets is an incredibly challenging task," said Maya MacGuineas, president of the Committee for a Responsible Federal Budget. "That's why you want to take preemptive action, rather than finding out what the point is where things boil over into a crisis."
At first glance, the United States has a debt load on the same scale as that of some European countries facing immediate problems raising money on the bond market. The United States is running a higher annual deficit and has more total debt relative to the size of the economy than Spain or Portugal.
But the United States is different in some fundamental ways. U.S. government debt has long been viewed as the safest port in any global storm, meaning that whenever the world economy looks shaky, money floods into Treasury bonds and makes it easier for Uncle Sam to maintain high debt levels.
And unlike Greece and Ireland, which use the euro, the United States has its own currency. Any flight by investors from the United States would cause the dollar to decline in value, acting like a pressure relief valve. It would lower American standards of living by making imported goods more expensive but also make U.S. exporters more competitive and thus help the economy avoid a complete free fall. That dynamic, for example, has helped crisis-stricken Iceland recover from an extreme crisis, but is not available to countries that use the euro.
With the U.S. unemployment rate showing little sign of falling soon, many economists who traditionally fret over budget deficits are now urging continued spending and low taxes to help encourage growth.
"We could do a lot to mitigate the costs of the recession at a relatively low cost by helping those who are hurt by the recession, including through extending unemployment benefits," said William Gale, a senior fellow at the Brookings Institution. "Austerity is not going to turn the economy around, and in this situation no responsible economist thinks that cutting spending massively is going to help the economy in the near term."
President Obama's deficit commission last week put ideas for longer-term deficit reduction on the table that Congress has not previously embraced, such as eliminating a variety of special tax deductions including mortgage-interest deduction and cutting military spending.
While centrist economists generally recommend a free-flowing fiscal spigot today combined with gradual tightening over the coming years, neither Democrats nor Republicans consistently hew to this approach.
Congressional Republicans, for instance, are seeking to aggressively cut spending aggressively while aiming to extend Bush tax cuts indefinitely, which would increase long-term deficits.
And the Obama administration is pressing to keep the portion of the Bush tax cuts that applies to lower- and middle-income families indefinitely, while seeking a two-year freeze in salaries for civilian federal employees, which represents short-term fiscal restraint.