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?

4 Replies to “The United States’ Real Spending Problem”

  1. Graeme, while I agree with the sentiment, your data is way off. You need to look at the difference between private and public debt in the current crisis. Moreover, the Keynesian/neoclassical is primarily an ideological one, and ignores a whole swath of critical economics that has been toiling away for decades. One such response to the crisis is here: http://www.debtdeflation.com/blogs/manifesto/ which is not easy to get through, but any one of the points sets us off on a whole set of different debates. Even the exchanges between Keen and Krugman demonstrate the ideological foundations of each and how starting assumptions lead to dramatically different conclusions. Moreover, I am not a huge advocate of Keen, but there are much more critical perspectives out there as well. Don’t fall for the pundit trap of thinking they are actually discussing economics.

  2. Sorry, what data? I understand the difference between private and public debt, and obviously the former is a very serious problem that the government is completely failing to address. The solutions are different though. Of course I think that pro-debtor policies should be adopted, but I don’t think that’s a spending issue. How that should be addressed is a whole different debate, which sadly isn’t being had at all.

    And obviously you can’t separate ideology from economics; as I suggested, that’s one of the main reasons why things have been so bad for so long. But there are serious differences between Keynesian and Neoclassical economics, and relying on the latter has proven to be disastrous. If you want to talk about critical economics then fine; the crisis certainly revealed that the country’s economic foundations have serious flaws, and they really haven’t been addressed. That doesn’t get around the fundamental issue of demand; no matter what system you support, that’s something that you’re going to have to address. Government spending is the best way to do that right now. What are the alternatives?

  3. From your post: “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”
    From the link I posted:
    “there is already too much private sector debt, and neither lenders nor the public want to take on more debt.”
    A proposed solution:
    “A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt.”
    Now that is just Keen’s proposal, but it deals with some of your responses.
    Finally, from your post:
    “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 statement alone is highly ideological and does little to demonstrate the integral role neoclassical economics has had in politicizing the federal reserve and anti-inflationary, pro-market policies. The geopolitics of oil alone could point to many examples of how that statement is both deeply political and ideological. Stiglitz, for one, has spent a lot of time publicly criticizing such positions.

  4. Like I said, I do support pro-debtor policies, and having something along the lines of a “Modern Jubilee” would be wonderful for both economic and social justice reasons. That’s a whole different issue though, and doesn’t relate to the government’s fiscal policy. It’s very necessary, but so is government-driven demand at this point.

    And of course there are problems with the Fed’s focus on inflation over anything else, along with its almost religious reverence for the market. Certainly the crisis should have proven how wrong-headed these are, and the fact that it didn’t is very sad. The point is though that increased government spending, despite the fears of some of the more conservative market fundamentalists, won’t lead to inflation as demand won’t outstrip supply for quite a while. As far as Stiglitz goes, I generally agree with what he says. The Fed should focus a lot more on employment now to kick-start the economy, but I don’t think it’s going to champion more necessary fundamental changes. Keynesianism really seems to be the most you can really ask from it. That might be sad, but it’s a lot better than what the country has now.

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