Monday, August 18, 2014

Balanced Budget Fundamentalism And Economic Recovery

Fiscal policy mandated in the EZ has been contractionary.  Raising taxes and cutting government spending when interest rates are at the zero lower bound is contractionary.  Its nearly impossible for nations like France and Italy reduce their debt to GDP ratio to 3% when there is no growth, and even shrinkage, in GDP.  Wren-Lewis believes that the majority of academic economists believe that fiscal austerity is the wrong medicine in our current situation.  He offers several explanations for the devotion to fiscal austerity among politicians.  They seem to be obsessed with the prospect of inflation even when the risk of deflation is much higher and more difficult to reverse once it sets in.

He argues that the economic advisers to the political elite are part of the problem.  They ignore much of what they have learned about economic theory and they provide intellectual support for the solutions preferred by the politicians.  He also believes that the commitment to austerity is stronger in Europe than it has been in the US because of the sovereign debt crisis in Europe.  The bond vigilantes never threatened the ability of the US government to finance its debt.  On the other hand, the public in the US has always responded well to politicians who argue that they can balance the budget.  Ronald Reagan ran for election on that platform.  He even proposed a balanced budget amendment to the Constitution.  In practice, however, budget deficits during his administration reached historical highs.  His tax cuts did not increase tax revenues, as he argued, and he did not cut federal spending.  This did not lower his standing with the public which has a short attention span.  The Cameron government also did well in the UK election by focusing public attention on deficit reduction.  Fiscal prudence is a virtue that the public can understand.

No comments:

Post a Comment