We're Cutting the Deficit Too Much, Too Quickly
Cutting the deficit is creating a fiscal drag on the economy
June 13, 2013
We are cutting the deficit too much, too quickly. In doing so, we are creating a fiscal drag on economic growth and job creation, delaying further a full recovery from the Great Recession.
Recoveries from balance-sheet recessions caused by the excessive build-up of private debt, such as the one we experienced with the bursting of the housing bubble, are long and difficult. It takes time for private households to repair their balance sheets by paying down debt.
Until they do so, the public sector must step in to fill the demand hole left by the weakness in consumer spending and private business investment.By prematurely cutting the deficit with spending cuts and tax increases, we are prolonging the convalescence period with possible long-term damage to the economy.
The damage comes in two forms. The first is the erosion of the long-term growth potential of the economy. The longer workers remain unemployed, the more their skills atrophy and the less productive they become. And the longer private sectors delay major new investment, the more the future productive capacity of our private capital stock declines.
The second form of damage comes from distortions created by the over-reliance on monetary policy to stimulate growth. In the absence of supportive fiscal policy, the Federal Reserve has been forced to pursue extraordinary monetary measures. But each new round of bond buying and quantitative easing has produced diminishing returns in terms of economic growth and job creation and more worrying side effects, such as inflated asset prices and the misallocation of capital. Not surprisingly, the mix of easy money and tighter fiscal policy has increased the wealth of asset-owning upper-income Americans, but has done little to spur new investment or real income gains for working Americans — just the opposite of what policy should be trying to achieve.
If we want to avoid further damage, we need to reverse course on deficit reduction by increasing public spending. But we need to do so by focusing on public spending that will make us richer and more productive in the future. That means a public investment program to replenish our public capital stock — our roads, bridges, airports, electrical grids, our research and development — and to develop our human capital.