The United States’ Real Spending Problem

Politics, it is said, is the art of persuasion. Dialogue, debate, and informed decision-making are at the core of the democratic process, and the ability to present concise, convincing arguments that support one’s cause is the key to political success. In the United States’ current fiscal debates, one analogy has perhaps gained popular resonance above all others: that the national budget is similar to a household budget, and just like a family, the nation must keep its total spending within the strict limits of its collective income, so too must the federal government work to reduce its already unsustainable level of public debt through dramatic budget cuts, that will improve long-term economic performance. From Tea Party activists to President Obama himself, this reasoning has gained the status of common sense across the political spectrum. Outstanding disagreements, although contentious, merely surround what should be cut and by how much, with the basic principle of debt reduction through long-term spending cuts supported by a rare bipartisan consensus.

Image courtesy of respres, © 2008, some rights reserved.

Image courtesy of respres, © 2008, some rights reserved.

There is only one problem with this line of thinking: it violates the basic tenets of historically proven economic theory, and not only significantly impedes recovery, but is counterproductive for reducing deficits as well. National economies, needless to say, are far more complex than household budgets. More importantly, they are governed by fundamentally different forces. If a family falls into debt, then it is logical to focus on saving by cutting back on non-essential expenditures, meeting all outstanding financial obligations in the process. Applying such a model to the national economy, however, would be disastrous, and for a very simple reason: the current malaise is caused by a catastrophic lack of demand in virtually all sectors of the economy, which means that cutting back expenditures to focus on saving would only exacerbate the very problem at the root of the crisis. And that’s exactly what’s happening. People aren’t spending. Investors aren’t investing. Businesses aren’t expanding. Given the global nature of the crisis, not even export markets can compensate for these shortfalls. Conventional monetary policy has all but failed to solve the problem, to the point where the U.S. economy has become stuck in a liquidity trap, with high savings rates despite short-term interest rates at or near zero. In such a situation, fiscal expansion is essential to stimulate new demand. It’s true that the United States has a spending problem—it is simply not spending enough.

Total public debt will indeed grow by spending more; in fact, it is supposed to in times of economic crisis. But the apocalyptic fears of burdensome future costs are unfounded. Primarily, the government will never have to pay back its current debt; it must merely ensure that combined GDP growth and inflation are maintained at higher levels than outstanding interest payments. Growth will also increase government revenues while reducing expenditures on social services for the poor, transforming short-term deficits into long-term surpluses. The choice between economic recovery in the present and low debt-to-GDP ratios in the future is therefore a false one: recovery now means lower debt later, and government spending is essential for both. Such a scenario is not at all unforeseeable, as it is essentially how the country has addressed its debt problems in the past. Other concerns are similarly baseless. Barring any unforeseen external commodity shocks, inflation cannot occur when there is a lack of demand, and once growth has returned the Federal Reserve can easily adopt anti-inflationary measures to dampen any effects that current spending may have. This is being borne out by the markets, as 10-year bond yields remain, as they have throughout the financial crisis, historically low.

That neither party in Washington supports such a path to economic growth is a sad commentary on the current state of American politics. For Republicans, debates about public debt are seen in terms of the much broader ideological goal of limiting the size of the federal government and minimizing its role in society. Their arguments are usually justified in purely ideological terms more than anything else, and invariably involve dramatic cuts to social spending and (confusingly) lower tax rates that benefit the wealthy. The Democrats, for their part, have been little better; the 2009 stimulus prevented a far deeper and more lengthy depression, but it was not enough to provide for meaningful broad-based growth. By shifting their focus from fiscal expansion to debt reduction through spending cuts, they effectively turned their backs on the core issues of unemployment, public welfare, the revitalization of depressed communities and, importantly, addressing the issues that caused the crisis in the first place. The effects of these policies should not be surprising, with the most recent financial crisis capping off 30 years of stagnating middle and lower class incomes, endless boom and bust cycles, growing income disparities, decreasing social mobility, and the collapse of domestic industries that have historically driven economic growth. A better future is possible. The only problem is, who in Washington is going to stand up for it?