Thought du Jour

The official Republican response to President Obama’s State of the Union address, delivered by Representative Paul Ryan, urges lawmakers to cut spending quickly, to avoid the mistakes of European countries. But Republicans place European countries in a single bag, assuming that all behaved like Greece.

We believe the days of business as usual must come to an end. We hold to a couple of simple convictions: Endless borrowing is not a strategy; spending cuts have to come first. ….

Just take a look at what’s happening to Greece, Ireland, the United Kingdom and other nations in Europe. They didn’t act soon enough; and now their governments have been forced to impose painful austerity measures: large benefit cuts to seniors and huge tax increases on everybody.

“Remarks of Congressman Paul Ryan (R-WI)“, Washington, DC, 25 January 2011.

Paul Ryan (1970-), who has represented Wisconsin’s 1st district in the US Congress since 1999, now chairs the House Budget Committee.

Princeton economist Paul Krugman, in a NY Times column, exposes the Republican “myth of a failing Europe”, the myth of “a collapsing society groaning under the weight of Big Government”.

It’s a good story: Europeans dithered on deficits, and that led to crisis. Unfortunately, while that’s more or less true for Greece, it isn’t at all what happened either in Ireland or in Britain, whose experience actually refutes the current Republican narrative. ….

Let’s talk about what really happened in Ireland and Britain.

On the eve of the financial crisis, conservatives had nothing but praise for Ireland, a low-tax, low-spending country by European standards. …. And the truth was that in 2006-2007 Ireland was running a budget surplus, and had one of the lowest debt levels in the advanced world.

So what went wrong? The answer is: out-of-control banks; Irish banks ran wild during the good years, creating a huge property bubble. When the bubble burst, revenue collapsed, causing the deficit to surge, while public debt exploded because the government ended up taking over bank debts. And harsh spending cuts, while they have led to huge job losses, have failed to restore confidence.

The lesson of the Irish debacle, then, is very nearly the opposite of what Mr. Ryan would have us believe. It doesn’t say “cut spending now, or bad things will happen”; it says that balanced budgets won’t protect you from crisis if you don’t effectively regulate your banks ….

What about Britain? Well, contrary to what Mr. Ryan seemed to imply, Britain has not, in fact, suffered a debt crisis. True, David Cameron, who became prime minister last May, has made a sharp turn toward fiscal austerity. But that was a choice, not a response to market pressure.  ….

[T]here’s certainly no sign of the surging private-sector confidence that was supposed to offset the direct effects of eliminating half-a-million government jobs. And, as a result, there’s no comfort in the British experience for Republican claims that the United States needs spending cuts in the face of mass unemployment.

Paul Krugman, “Their Own Private Europe“, New York Times, 28 January 2011.

Elsewhere in the news today, contrary to Republican expectations, there is increased confidence in the euro, and in Europe’s ability to overcome its debt crisis.

[S]ince hitting a low of $1.2871 against the dollar on January 10, the euro has surged 6.9 per cent, notching up a two-month peak of $1.3759 on Thursday.

Sentiment towards the euro has improved dramatically ….

Thomas Stolper, strategist at Goldman Sachs, says there is potential for further gains in the euro. He forecasts a move to $1.40 against the dollar in three months followed by a gradual drift higher to $1.50 later in a year.

Peter Garnham and Richard Milne, “Sudden shift in euro catches traders off guard“, Financial Times, 28 January 2011.

NYU economist Nouriel Roubini, in his contribution to a week-long FT debate, criticizes Obama and his party for failure to address the problem of medium-term deficits. “The result”, he writes, “will soon be the worst of all worlds: neither short-term stimulus nor medium-term fiscal sustainability”.

What has been the fiscal performance of President Barack Obama? He inherited the worst economic crisis since the Great Depression, as well as a budget deficit that – after much needed bail-outs and a series of reckless tax cuts – was already close to $1,000bn. His stimulus package, together with a backstop of the financial system, low rates and quantitative easing from the Federal Reserve, prevented another depression. Mr Obama also deserves credit that the US, alone among advanced economies, currently supports a “growth now”, rather than an “austerity now” path.

But this is but one half of the picture; we must also judge his first two years on his ability to anticipate what the economy will need tomorrow. Here the picture is much less positive. Given the likely path of fiscal policy after next Tuesday’s election – with the expiration of existing stimulus and transfer payments, and even with most of the 2001-03 tax cuts being kept – the US economy will soon experience serious fiscal drag just when it needs a further boost. ….

In an ideal world Mr Obama would also have been able to move towards reforming and reducing entitlement spending, with commitments to measures that could be phased in over the next few years, therefore avoiding short-term fiscal pain. He would also have committed to increase, gradually over the next few years, less distortionary taxes such as a VAT and a carbon tax. This would have reduced the fiscal deficit, and created a climate in which no investor would worry about additional stimulus.

Sadly, this has not happened. In fact the opposite will now take place.

Nouriel Roubini, “A presidency heading for a fiscal train wreck”, Financial Times, 29 October 2010.

Roubini’s views support those of Princeton economist Paul Krugman, who writes:

[W]e very much need active policies on the part of the federal government to get us out of our economic trap.

But we won’t get those policies if Republicans control the House. In fact, if they get their way, we’ll get the worst of both worlds: They’ll refuse to do anything to boost the economy now, claiming to be worried about the deficit, while simultaneously increasing long-run deficits with irresponsible tax cuts — cuts they have already announced won’t have to be offset with spending cuts.

Paul Krugman, “Divided We Fail”, New York Times, 29 October 2010.

A key difference between the two economists is that Roubini does not blame the Republicans for virtually everything. Roubini acknowledges that Obama “is limited by an unco-operative Republican party”, but adds that Democrats “have been unwilling to tackle long-term entitlement spending … and this means the US remains on an unsustainable fiscal course”.

I rarely link to Paul Krugman, on the assumption that everyone reads his columns and his blog. But this post is too good to ignore.

The 10-year bond rate is about 2.5 percent, lower than it was when [Niall] Ferguson made that prediction [of rising interest rates from fiscal stimulus]. Inflation keeps falling. The attacks on Keynesianism now come down to “but unemployment has stayed high!” which proves nothing — especially because if you took a Keynesian view seriously, it suggested even given what we knew in early 2009 that the stimulus was much too small to restore full employment.

The point is that recent events have actually amounted to a fairly clear test of Keynesian versus classical economics — and Keynesian economics won, hands down.

Paul Krugman, “How The Other Half Thinks”, New York Times Blog, 2 October 2010.

The “austerity debate” continues at the Financial Times. Today there is only one contribution, from Columbia University economist Jeffrey Sachs. Professor Sachs agrees there is need for stimulus, but argues that what needs to be stimulated is investment, not consumption.

The striking feature in the current debate about austerity and stimulus has been the lack of attention to investment. Consumers will not provide the engine of recovery, nor should they after overspending for a decade. Instead, the US and Europe should be using the recent corrective boost in saving rates to promote long-term investments in physical and human capital as the proper way back to sustained growth. ….

At a time when China is building hundreds of miles of subway lines, tens of thousands of miles of highways, a couple of dozen nuclear power plants, and a network of tens of thousands of miles of high-speed intercity rail lines, the US struggles to launch a single substantial project. China saves and invests; the US talks, consumes, borrows, and talks some more.

It is wrong in this context to believe that the only choice is further fiscal stimulus versus a repeat of the Great Depression. Further short-term tax cuts or transfers on top of America’s $1,500bn budget deficit are unlikely to do much to boost demand, while they would greatly increase anxieties over future fiscal retrenchment. Households are hunkering down, and many will regard an added transfer payment as a temporary windfall that is best used to pay down debt, not boost spending.

Jeffrey Sachs, “Sow the seeds of long-term growth”, Financial Times, 22 July 2010.

Sachs’ proposal for a “US investment recovery plan” consists of government spending on clean energy and infrastructure and “more education spending at secondary, vocation and bachelor-degree levels”.

Paul Krugman, who works for a rival newspaper, is not participating in the FT debate. Nonetheless, Krugman is clearly in the stimulus camp on this issue. In two blog posts (here and here), Krugman responded to Ken Rogoff’s assertion that there is “No need for a panicked fiscal surge”.