The world is in the grip of a debate between fiscal austerity and fiscal stimulus. Opponents of austerity worry about contractionary effects on the economy. Opponents of stimulus worry about indebtedness and moral hazard.
Is austerity good or bad? It is as foolish to debate this proposition as it would be to debate whether it is better for a driver to turn left or right. It depends where the car is on the road. Sometimes left is appropriate, sometimes right. When an economy is in a boom, the government should run a surplus; other times, when in recession, it should run a deficit.
In the 1955 movie Rebel Without a Cause, James Dean and a teenage rival race two cars to the edge of a cliff in a game of chicken. Both intend to jump out at the last moment. But the other guy miscalculates, and goes over the cliff with the car.
This is the game that is being played out in Washington this month over the debt ceiling. The chance is at least 1/4 that the result will be similarly disastrous.
It is amazing that the financial markets continue to view the standoff with equanimity. Interest rates on US treasury bonds remain very low, 3% at the ten-year maturity. Evidently it is still considered a sign of sophistication to say “This is just politics as usual. They will come to an agreement in the end.” Probably they will. But maybe not. (I’d put a ½ probability on an agreement that raises the debt limit, but just muddles through in terms of the genuine long term fiscal problem. That leaves at most a ¼ probability of a genuine long-term solution of the sort that President Obama apparently proposed last week – described as worth $4 trillion over ten years.)
Evidently the four-word slogan “No Taxation Without Representation” is too complicated to fit on some people’s bumper stickers. They have chopped off the last two words. They don’t want taxation period.
The “Tea Partiers” revere the Constitution. But some might lack the knowledge of early American history that they claim. In honor of George Washington’s birthday, February 22, I would like to recall a bit of that history.
The Boston Tea Party is not in fact the most appropriate historical precedent for the grass roots protests that have received so much attention over the last year. The famous slogan motivating the patriots in Boston Harbor in 1773 was “No Taxation Without Representation.” But democratic representation was achieved with the American Revolution. The Whisky Rebellion of 1794 is a much closer parallel for today’s protestors. Or the earlier Shays’ Rebellion of 1787, the episode of anarchy to which many Americans reacted by seeking a federal constitution. The pitchfork-carriers in these rebellions were protesting against taxation with representation. They did not want to pay the taxes necessary to fund the government services they enjoyed — which at that time meant servicing the debt from the Revolutionary War. (Sound familiar?) President George Washington, not the rebels, was defending the Constitution against its first severe test, when he personally put down the Whiskey Rebellion with force.
During much of the last decade, U.S. fiscal policy has been procyclical, that is, destabilizing. We wasted the opportunity of the 2003-07 expansion by running large budget deficits. As a result, in 2010, Washington now feels constrained by inherited debts to withdraw fiscal stimulus at a time when unemployment is still high. Fiscal policy in the UK and other European countries has been even more destabilizing over the last decade. Governments decide to expand when the economy is strong and then contract when it is weak, thereby exacerbating the business cycle.
President Obama proposes allowing the Bush tax cuts to expire next year — as they are scheduled to do if nothing is changed — for those earning more than $250,000, but changing the law so as to extend the tax cuts for those earning less than that amount. Republican politicians are opposing the proposal. I don’t understand what they are thinking. Their position doesn’t make sense to me, regardless whether they are thinking about short-term stimulus, long-term fiscal conservatism, good economics, or even pure politics.
The first thing to say is that Barack Obama took over the presidency at an extremely difficult time. A variety of analogies suggest themselves: He is Harry Houdini who has been thrown in the river, in a straitjacket, with chains wrapped around him. Or he has taken over as the captain of a ship with a rotting hull, while the ship is under attack in a hurricane. To capture the state of the economy, perhaps the best metaphor is that Obama took over as pilot of an airplane in the middle of a steep dive. For a president precedent, he is Lincoln, who takes office as the South secedes. Or he is Roosevelt, who takes office at the depth of the Great Depression.