Monday, January 25, 2010

Un-Tastee Freeze

President Obama will propose a freeze on non-'security-related' discretionary spending in the State of the Union. The Times reports:
Fiscally conservative Democrats in the House and Senate have urged Mr. Obama to support a freeze, and it would suggest to voters, Wall Street and other nations that the president is willing to make tough decisions at a time when the deficit and the national debt, in the view of many economists, have reached levels that undermine the nation’s long-term prosperity. Perceptions that government spending is out of control have contributed to Mr. Obama’s loss of support among independent voters, and concern about the government’s fiscal health could put upward pressure on the interest rates the United States has to pay to borrow money from investors and nations, especially China, that have been financing Washington’s budget deficit.
Ahem. Who are these "many economists" you speak of?

While there is legitimate reason to be concerned the US government's projected borrowing needs could lead to higher interest rates and "crowding out" of investment when the economy recovers, we are not there yet, not even close. But don't take my word for it, ask the bond markets:
As long as unemployment remains severely elevated, cutting spending (and a nominal freeze is a real cut) is exactly the wrong policy. The magnitudes are small, but as Brad DeLong writes:
What we are talking about is $25 billion of fiscal drag in 2011, $50 billion in 2012, and $75 billion in 2013. By 2013 things will hopefully be better enough that the Federal Reserve will be raising interest rates and will be able to offset the damage to employment and output. But in 2011 GDP will be lower by $35 billion--employment lower by 350,000 or so--and in 2012 GDP will be lower by $70 billion--employment lower by 700,000 or so--than it would have been had non-defense discretionary grown at its normal rate. (And if you think, as I do, that the federal government really ought to be filling state budget deficit gaps over the next two years to the tune of $200 billion per year...)

And what do we get for these larger output gaps and higher unemployment rates in 2011 and 2012? Obama "signal[s] his seriousness about cutting the budget deficit," Jackie Calmes reports.

Andrew Leonard says:

If ever there was a time to pull out the old Karl Marx chestnut, "History repeats itself, first as tragedy, second as farce," that moment is now. Prominent members of Obama's own administration have warned against repeating the errors of 1937, namely, Franklin Roosevelt's decision to cut spending and balance the budget too quickly, thus strangling a nascent recovery from the Great Depression. But with the U.S. economy far from healthy, the president has decided, once again, to bow to the political winds and make the deficit priority number one.

If the President wants to do something serious about the long-run fiscal problem, without making the economy worse in the short-run, two options are:
  • Get health care reform passed. The main driver of increases in projected future deficits is growth in government health care spending (Medicare, etc.) due to rising health care costs. The bills passed by the House and Senate both take steps in the direction of curbing cost growth.
  • Let the Bush tax cuts expire. Maybe not as scheduled after this year - since unemployment will still be high, the "sunset" should be pushed back a year or two - but don't make them permanent.
Sigh. Hopefully this will look better when we see it in context of the other proposals in the State of the Union.

(And I cannot help but wonder: would all this be happening if the Democrats in Massachussetts hadn't managed to find the one person in New England who doesn't know who Curt Schilling is and nominate her for Senate?)

Update (1/27): See also Paul Krugman, Ezra Klein. James Kwak fears he's turning into Bill Clinton (though he says: "I'd rather be a really good one-term president than a mediocre two-term president").

Vice-President Biden's economic advisor Jared Bernstein defends the policy:
First, an important note on timing. No one is arguing that we should take our foot off the accelerator today, when the economic recovery remains fragile and job growth has yet to return. In fact, you’ll hear from the President tomorrow night about measures we should undertake right away jumpstart job creation. In his words and deeds, the President has made clear that recovery comes first. But that doesn’t mean we should wait to start changing the same bad habits in Washington that left a $1.3 trillion deficit on our doorstep when we entered office in January 2009, especially when we can do so without cutting back on our jobs agenda.

Second, a little background on freeze-eology: there are two ways to do a freeze like this: (1) an across-the-board freeze on every program outside of national security; and (2) a surgical approach where overall totals are frozen but some individual programs go up and others go down. In short, a hatchet versus a scalpel.

During the campaign, you may recall that John McCain touted option 1 – the hatchet approach of an across-the-board freeze.

The President was critical of that approach then, and we would be critical of it now. It’s not what we’re proposing. To the contrary, the entire theory of the President’s proposed freeze is to dial up the stuff that will support job growth and innovation while dialing down the stuff that doesn’t. Under our plan, some discretionary spending will go up; some will go down. That’s a big difference from a hatchet.

Noam Scheiber explains what they may be thinking.

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