Deficit Spending Should Be Counter-Cyclical (Not Pro-Cyclical)

Born-Again Fiscal Hawks Turn Into Doves
Funny how some folks stop caring about federal deficits after an election
Bloomberg, August 28, 2017



One of the weirdest things to come out of the financial crisis was the rise of the born-again fiscal hawks, as I called them in 2010. These are the folks who had never shown much interest in fiscal restraint before, but very suddenly became concerned about deficit reduction. Coincidentally, their awareness of the evils of deficits occurred sometime in late January 2009, once they were no longer in power in Washington.

Both major political parties engage in deficit alarmism, although it would be a false equivalency to suggest they do so equally.

Max Abelson at Bloomberg Businessweek pointed out that the most recent version of the shift on the importance of deficit reduction was dependent upon whose guy was in the White House:

It was only about five years ago that powerful people in finance loved talking about the horrendous consequences for the U.S. if it didn’t get its finances under control. They warned that the federal debt—and the interest payments—could eventually get high enough to drag down the economy, burden future generations, and even threaten national security. Chief executive officers of five of the biggest U.S. banks joined a campaign called Fix the Debt, signing on with hedge fund billionaires, asset managers, and private equity executives, as well as former lawmakers and others.

Then their guy won the White House in November, and reducing deficits suddenly became a nonissue.

This sort of behavior is intellectually dishonest, hypocritical, economically counterproductive and, at times, even dangerous. It has been going on for too long.

Consider a short anecdote about a president elected amid a major economic slowdown and a decade-long bear market for stocks. He came into office on feel-good oratory and a winning personality, but was regarded by many as a lightweight. He passed important legislation over the objections of a hostile opposing party. The pundits and policy wonks derided his big spending program, warning that therein lay fiscal ruin and damnation.

But Ronald Reagan (and you thought I was referring to Barack Obama) ignored the critics. His deficit spending and tax cuts helped stimulate the economy and led to an economic recovery that lasted for the better part of a decade. 1

This is further support for the playbook laid out by John Maynard Keynes in “A Treatise on Money,” written almost 90 years ago: The government acts temporarily to replace missing corporate and household demand during recessions by increasing spending.

Both Reagan and Obama had the big concept right; the time for stimulus through the combination of deficits and tax cuts is during a bad downturn. When private-sector demand crashes, the government can replace it temporarily with the proper programs.

Unfortunately, the last cycle after the Great Recession didn’t see this sort of broad, deep and well-funded effort. Instead, because Obama was facing hysterical opposition, the country ended up with:

  • Temporary tax cuts, which do little to drive long-term private-sector investment;
  • Other temporary fiscal measures, such as extended unemployment, which only work while they are in effect;
  • So-called shovel-ready projects, most of which didn’t lay the foundation for long-term growth.

Both Obama and Reagan got the specifics of their stimulus programs wrong. Obama should have focused a bigger spending package on infrastructure and updating depleted military units. (By way of contrast, consider the interstate highway program put into place under President Dwight Eisenhower. The positive economic impact of that project is still being felt today.) Reagan’s stimulus, meanwhile, concentrated too much on expanding the military, which does less to boost the economy than other forms of government spending.

I am not suggesting that deficits don’t matter (they do) or government tax and spending policies should be profligate and irresponsible (they shouldn’t). However, given the low borrowing rates the U.S. Treasury enjoys, it’s pretty clear that Mr. Market isn’t very concerned about deficits today.

But the timing of these issues matters a great deal. Keynes had it right — the time for government spending increases and tax cuts is when things are going poorly; when a recovery is more mature, that’s the time for limiting deficits.

In the not-too-distant future, the U.S. economy should be strong enough to absorb a withdrawal of extraordinary measures, including the Federal Reserve’s emergency monetary stimulus. Had Congress done its part on the fiscal side back in 2009, the economy would have been in much better shape — and sooner — than it is today.


1. I would be remiss if I failed to mention how much credit former Federal Reserve Chairman Paul Volcker deserves for the subsequent recovery by raising rates high enough to break inflation, but causing a severe recession in the process.


Originally: Born-Again Fiscal Hawks Turn Into Doves

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