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Near-Term Budget Cuts a Major Threat to Economy

My latest piece for The American Prospect is up, looking at the effect of near-term budget cuts on the economy. Everyone in Washington is looking hopefully at the Biden debt limit negotiations, but the solution could easily be as bad as the consequences of inaction, if Republicans force immediate cuts in exchange for any deal. Here’s an excerpt:

The budget framework that House Republicans are using for appropriations bills, which serves as an indication of what they want from a debt-limit deal, restricts discretionary spending by $103 billion more than 2010 levels, a cut of 21.5 percent, according to the Center for Budget and Policy Priorities. “It definitely violates the ‘do no harm’ principle in the short term,” said CBPP’s Chuck Marr, who estimates a loss of 1 percent of GDP this fiscal year under the Republican budget. Nonetheless, the Republican Study Committee, a conservative rump faction, wants an even larger spending reduction for FY 2012, some $380 billion in cuts. According to Larry Mishel of the Economic Policy Institute, cuts at that level would ensure a double-dip recession.

One only needs to look to Britain, which cut $180 billion from its budget last year, to preview the disastrous effects of such a cut. The economy shrank, and real household income dipped to its lowest level since the 1930s. “There’s no way that budget cuts are not going to slow down the growth of the economy,” said EPI’s Mishel.

Dave Johnson was thinking along the same lines today.

Here are some annotated notes, though I’d like you to read the whole piece. First of all, the theory that a fiscal contraction at this point can lead to expanding the economy makes no sense at all. Conservatives are waving around a study that supposedly shows this, but Jared Bernstein makes minced meat of it. It turns out that the study actually shows that deficit reduction only worked to increase growth once economies returned to full strength. To engage in it now, while an economy is weak, is suicidal. But that’s the path that not only House Republicans, but the White House, is on right now. Mike Konczal explained that “confidence” is the new buzzword for the Administration, as in: cutting the deficit will provide confidence for businesses and boost economic growth.

As Dean Baker explains, this is entirely faith-based, and at variance with the numbers. If the economy were suffering from high interest rates, perhaps deficit reduction that lowered the cost of borrowing would be helpful. But interest rates on US debt is extremely low. None of the other arguments from the deficit cutters work either. It’s clear that they just want to administer some pain as an end in itself, and they’ve come up for a model for how it can work for them. I thought the quote from EPI’s Larry Mishel at the end of my Prospect piece about summed it up:

“I think it’s bogus,” said Mishel, of EPI. “And it reflects what happened in the Clinton era, when you elevate a tactic to the level of principle. They feel politically forced into shifting to deficit reduction. And they now rationalize this as good for jobs. And I think they all know better.”

The problem with the economy is not confidence. It’s that businesses aren’t hiring because there’s depressed demand for their services. Heck, even Larry Summers gets this. It’s a standard economic response to the situation we’re in. His neoliberal solution, which I outlined in the piece, is short-term stimulus combined with medium-term deficit reduction. As Konczal writes, at least there’s an internal logic there. But this new approach, that confidence alone will boost growth, “is just substituting in the interests of bondholders for the entire economy.”

And it’s really liable to come back and haunt this Administration. Mitt Romney has no ideas to help the economy that are any different than the White House, but he’s not in charge and they are. So he can damn the Administration’s economic policies by telling a human story, over and over again, and reap much success from it. Cutting the budget now will only give Romney more fodder for his ads.

Finally, at the risk of saying I told you so, let me say I told you so. When the Administration inked the tax cut deal last December, I knew that the deal hadn’t ended and the second half of it hadn’t kicked in. That would play out with the 2011 and 2012 budgets and the debt limit vote. And just as predicted, that will lead to a major fiscal contraction, one that will shave quite a bit of GDP growth and hundreds of thousands of jobs. So was it worth it to keep the Bush tax cuts going for another two years, then?

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David Dayen

David Dayen