Ideology and economics
Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.
For ideological reasons, one might believe that limiting or reducing government is better. However, it does not follow that doing so is a painless exercise.
If one does want to see government expenditure reduced for ideological reasons, the question is when and how to do so. Clearly, doing so in an abrupt way after a credit bubble is going to be the wrong way. I believe both President Obama in the US and Prime Minister Cameron in the UK understand this. They are trying to make cuts (or reduce the pace of growth) in a way that doesn’t lead to the outcomes we saw in Ireland, Latvia, or Greece. It remains to be seen whether they will be successful.
Still, we have to be clear what is happening here: Post credit bubble fiscal austerity leads to depression. We are making cuts that suck money out of the economy – and there is no confidence fairy that causes businesses or households to compensate for that adjustment as President Obama points to. Rather, the desire to save in the private sector is due to the need for deleveraging in the household sector and Corporates spending like it’s the 50s due to business uncertainty in the business sector.
Basic accounting tells us that when the private sector wants to net save, a reduction in government expenditure leads to a concomitant reduction in private sector expenditure as well and a loss of jobs – just the opposite of what the confidence fairy in voodoo economics would say. And that means, in the short run, focusing on deficit reduction increases deficits unless the cuts are very, very large.
Everyone knows the debt ceiling debates are not about deficits anyway. It’s about limiting government for ideological reasons. Why the Republicans don’t just say so is beyond me. I reckon it is because they fear people will be more resistant to supporting their agenda if they knew the real reasons behind it. Look at how seniors in New York have rejected Paul Ryan’s Medicare plans for example. So the Republicans have chosen deficit reduction for ‘bureaucratic reasons’.
Ostensibly the rationale for limiting government is because the debts and the waste are just too great. Real resources are being diverted away from more efficient and more socially desirable uses in the private sector. We do know, however, that cuts dealing with discretionary spending, and not with Medicare or Military spending, are chicken feed. Moreover, the US federal government budget would be balanced at full employment and a slight trade surplus. Social Security and Medicare are longer-term issues.
To me that says full employment is the shorter-term issue, entitlements and military spending are the longer-term issues. Realistically, you could cut future deficits by cutting future military spending, raising future Social Security age limits, and build in means testing to Medicare and Social Security without affecting the current economic situation. This is a political loser, though.
As far as the short- to medium-term go, remember that households are currency users while government creates the currency. That means government doesn’t face the same liquidity constraints that households do. The household analogy for government, while effective for people who don’t understand this, is flawed. Looking at Greece’s brush with default and sky-high interest rates shows us this. Greece with its 160% debt-to-GDP is a currency user in EMU, while Japan with its 200% debt-to-GDP is a currency creator like the US.
The expectations theory of interest rates tells us that long-term bond yields largely reflect consensus estimates of future short-term rates plus a liquidity premium. The bond vigilante wolves are simply not coming to blow our house down. Long rates reflect inflation and interest rate expectations. Full stop. The Fed could well target long-term rates with ‘rate easing’ if it so chooses, something that would be more effective than ‘quantitative easing’.
On the other hand, If you abdicate currency solvency as governments in Euroland have done, then, yes, the wolves will blow your house down.
In the quote at the outset, President Obama has simply chosen to use voodoo economics to justify something that will weaken the economy. Not only is it foolhardy to do so because it plays into his opponents’ hands, it is simply bad economics.
I may write up how to put this in terms that has the economics right – i.e. that satisfies key planks of Austrian small-government ideology but also gets the accounting tautologies right. Maybe then people will understand the issues.