Wednesday, July 20, 2011

CCB. Cut, Cap, and Balance, or Catastrpohic and Complete Bull?

An absolute must-read from BillyBlog.

This is technical stuff, but understanding it is essential to understanding how badly we're being sold out by Washington. All of them, although the specific target of the post is the Tea Party Republican "plan" to deal with the budget (non)crisis.

Some key points:
  • It is very clear when you examine the data that the US fiscal stimulus – however ill-directed and small it was relative to the problem being faced – has provided for some growth in output and income and that is supporting the saving intentions of the private domestic sector.
  • They mention future tax burdens on our grandchildren and things like that but not much discussion is about now. When there are hints about the behaviour of other sectors the Ricardian Equivalence arguments seem to drift in – so – every one in the private sector is cashed up to hell and are just waiting to spend like crazy – like trillions crazy – as soon as they realise the US government is going to get off their future tax backs.
  • All the evidence says that that is a ridiculous assumption to be making in relation to the behaviour of the private sector which is heavily indebted, facing declining house prices (and negative equity) and with many families moving closer to poverty as a result of unemployment (that is, their “savings” are being or have already been exhausted by unemployment).
  • With unemployment entrenched close to 10 per cent and long-term unemployment rising into record levels in the US and inflation falling it is very hard to say that the spending flows that define the deficit are excessive – which is quite apart from any erroneous discussions about whether they are sustainable.
  • If the deficit wasn’t at 10 per cent of GDP right now inflation would be falling more quickly and unemployment would be rising very quickly. More firms would be going broke and shedding labour and many more families would be defaulting on their debts.
  • The basic macroeconomics equation – Spending equals income. If you cut spending you cut income. If you cut income you cut spending – and then output and employment are lower.
  • If the cuts really were around 4.9 per cent of GDP then the IMF modelling suggests that domestic demand would fall by 4.9 per cent (that is obvious) and via an Okun-law type equation this would translate into a rise in unemployment of around 1.5 per cent. I think it would be higher than that because the IMF modelling is very (very) conservative.
  • The requirement that budget should be balanced in each year not only restricts the fiscal powers that governments would ordinarily enjoy in fiat currency regimes, but also violates an understanding of the way fiscal outcomes are effectively endogenous.
    A sharp negative demand shock which causes an economic downturn will reduce tax receipts and increase benefits, automatically increasing the deficit. Reducing government expenditures in that situation to meet the rule will worsen (prolong) the recession, which is then likely to involve the country in even higher deficits.
    The vicious circle of spending cuts implied is unsustainable and amounts to fiscal vandalism. In other words, fiscal policy becomes biased to pro-cyclical impacts violating any sensible ambitions that are the ambit of responsible fiscal management.

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