The CBO just came out with a new report providing projections on what will happen if we go off the fiscal cliff. On the one hand it is showing that we will go into recession next year, with GDP falling 0.3% and unemployment rising to 9.1%, but our deficit will shrink dramatically, going from over $1 trillion down to $641 billion. Longer term, the CBO estimates that debt held by the public will be 58% of GDP in 2022 instead of 90% if we avert it. Essentially the choice is a mild recession in 2013 and righting the fiscal ship or growing at a meager 1.7% next year and kicking the debt can down the road. With such framing, you can easily convince yourself to just go over the cliff and deal with the short term consequences. Unfortunately, the CBO estimates are complete fantasy with no basis in reality.
Taxes are set to go up by 3.4% of GDP next year, this is money that is going to be taken out of people's pockets and will just disappear. It's not like the government will increase spending with that money, they will spend about the same amount regardless of whether the taxes come in or not. That means there will be nothing to counterbalance the tax increase to cushion the blow to the economy. So if 3.4% of GDP simply disappears, you would expect that GDP would contract by at least 1.7% next year, not the 0.3% that the CBO estimates. But even that is underestimating how bad the recession will be next year as the tax multiplier is over 1. Every dollar that a taxpayer spends is then often spent by the businesses and on and on. Some believe that the tax multiplier could be 3, so if you use that figure, you would expect a negative impact totaling 10.2% of GDP, which would lead to us having a down 8.5% GDP year in 2013. Another reason to expect a much worse than expected 2013 is that our economy is already slowing because of weakness in China and Europe. There is a chance we would go into recession next year even without the fiscal cliff, so if you add the fiscal cliff to that and you get a severe economic contraction. If our economy was going to have a down 1% year next year due to the global economic slowdown and then 3.4% of GDP vanishes, you suddenly have a down 4.4% year and that is with a tax multiplier of only 1! We could be headed for economic disaster if we increase taxes by that amount when the economy is slowing at the same time.
Another issue I have with the CBO estimate is its long term projections for GDP. They expect to have just a short 1 year recession with real GDP growing at 3.1% in 2014 and a whopping 4.8% in 2015. They then expect no recessions at all through 2022, which is pretty remarkable considering we seem to be set to have our third recession in 12 years. What this means is that the CBO's long term debt forecasts are completely bogus. Our debt in 2022 is likely to be much larger than 58% of GDP as the debt will likely be larger (due to higher than expected deficit spending in recessions) and GDP is likely to be smaller (as we aren't likely to have the hypergrowth and recession-free period as the CBO forecasts suggest).
I suspect the CBO just gave the politicians enough rope to hang the country with.
I don't know anybody who can explain how Romney will improve the economy or the deficit. Ryan's budget, which certainly makes some tough cuts, would actually increase the deficit because of tax cuts.
ReplyDeleteI'm going to describe to you how all the economists I can find who offer a prescription say such a severe recession should be dealt with. I would appreciate it if you could explain to me why this is wrong, and why less government spending and more tax cuts for the rich will turn the economy around. I am sincerely asking, I really can't find a reasonable argument for the Romney/Ryan position.
The argument for government spending is this.
At the moment a huge financial crisis, brought about by deregulation of the financial markets has left very high unemployment, and many people, although they still have jobs, have massive losses in their savings, are underwater in their mortgages, and generally have no money to spend. This means there is no demand for goods and services and the economy has ground to a halt.
The government can borrow money at the moment for virtually no interest. In spite of the silly down-grading of U.S. bonds last year, they are still the most secure, and therefore lowest interest-paying, investment in the world. With inflation so low the government can essentially borrow money for free. If the G. spends money right now to, for example, build roads, many people would need to be hired, and these people would spend their wages immediately, as they have been going short for a long time. The money will circulate and demand for goods and services would increase, opening opportunities for investment. The trillion dollars in the hands of major holders that appears to be uninvested at this point would have an outlet, it could be invested in providing goods and services. If these actions created some inflation, that would be to the good, as that would provide still more incentive for the currently unused capital to be invested, in order not to lose its value. As the economy grows, tax revenues will increase and the deficit will shrink.
Why do I believe this to be the case? There are many historical examples of precisely this happening, but the most famous is the recovery from the Great Depression. When the Govt cut spending when we were seeing a slight recovery it plunged us back into depression. When spending increased massively because of the war, the economy boomed, and went on booming for a long time, defended from financial crises by the regulations imposed on finance after the crash.
Okay- that's a simplified version, and holes can be poked in it. I can poke them myself, and I'm sure you already know this argument well. Now could you explain to me what the Libertarian Neocon argument is? Or Romney/Ryan's argument? I know they talk about "business confidence" and threaten that hyper-inflation is just around the corner, but what historical example do they point to where belt-tightening saved an econmy? What's the narrative of how they're going to bring jobs back by cutting spending? I genuinely don't know and can't find an explanation. I had had a dialogue on this blog about public schools, and thought perhaps you might offer an description of the conservative recovery plan, and evidence that supports it.
Thanks, Sasha Cooke