The President will sign another $33 billion extension of unemployment benefits this week, and this is only the beginning of a debate almost certain to produce some uncomfortable moments for both parties. For now, the Republicans have embraced the more shameless position. Their new talking points tell us that the economy cannot afford any new measures that would increase the deficit – a very long way from Reaganomics, indeed. But all this comes on top of the previous GOP story line that the slow economy and high jobless rate prove that the President’s economic program has failed. With no evidence that global investors have any qualms at all about U.S government debt – if they did, the market yield on Treasury bills wouldn't hover around one-third of one percent – the slow economy they use to blame Obama should be entirely able to absorb more deficit spending without problems. It’s true that consumer spending and business investment remain weak, and American companies aren’t creating many new jobs. But even most GOP economists concede that the combination of the 2009 stimulus package and two years of near-zero interest rates from the Fed explain why we moved from monthly job losses of a half million or more to small monthly gains, and from output contracting at a 4 to 5 percent rate to output growing again moderately.
But it’s not enough to produce a healthy expansion, because economies hit by financial meltdowns need stronger and different medicine than easy fiscal and monetary policies. So, while Democrats are right that an economy as weak as this one won’t be harmed by another modest dose of deficit spending, it also won’t help the overall economy much. That’s because it doesn’t touch the underlying forces holding down growth and jobs, which are the same forces that drove the crisis. To begin, high unemployment isn’t the only or most powerful force holding down consumer spending. Americans aren’t spending like they used to, mainly because the sharp fall in housing markets has left most of us a lot poorer than a few years ago. And there’s no relief in sight while home foreclosures continue to run at several times their normal rates, further depressing housing prices.
There’s a similar story behind business investment, which still lags because nearly two years after the crisis peaked, the financial institutions that dominate business lending remain weak. The Paulson and Geithner Treasuries both rejected not only the original TARP plan to buy up the sick assets held by those institutions – which admittedly would have been hard to carry off successfully – but also calls to take over failing banks, remove those assets from their balance sheets, and sell off new, healthy entities. Since they also didn’t come up with another way to sequester the junk from the rest of the system, financial institutions are still saddled with hundreds of billions of dollars in bad assets and derivatives. And with the housing market still driving down the value of many of the mortgage -backed assets that remain on the books of the big banks – and sovereign debt markets in Europe also looking perilous – financial institutions are still writing down losses and hoarding capital for the next storm. Again, monetary and fiscal stimulus – or austerity for that matter – can’t solve the problem.
In the face of these daunting difficulties, much of Washington has decided to yell about deficits. Even so, they can’t quite get their stories straight. Republicans unwilling to let the deficit rise by $33 billion for one year to give jobless Americans a little more assistance, insist nevertheless that Congress reenact the Bush 2001 and 2003 tax cuts for high-income Americans, set to sunset this year, at a cost to the deficit of $750 billion over 10 years. And quite a few Democrats who point out that abrupt austerity measures could easily hurt a slow economy still won’t consider extending those tax cuts for even a year or two. Neither side can have it both ways.
If Republican really believe that temporary increases in the deficit are dangerous, they should be leading the fight to roll back those tax cuts. And if Democrats really believe that cutting the deficit in a slow economy is dangerous, they should be calling on the President to preserve the same tax cuts. However, between the contradictions on both sides may well lay the seeds for a sensible, Washington compromise.
While economists may argue about the effects on a slow economy of temporary increases in spending or tax incentives, they generally still agree that once the economy is healthy, the large deficits now forecasted for years to come will begin to displace private investment and drive up interest rates. At a minimum, that should mean no new, permanent tax cuts or spending programs. So, here’s the compromise: Extend the Bush tax cuts for high-income Americans for two years, at a cost of $75 billion, and match it with $75 billion over two years in additional assistance to the states, now facing the prospect of laying off tens of thousands more police, teachers, and other public servants. And if that’s too brazen for the deficit hawks, add a measure or two that would raise $150 billion over the following three to five years. In a spirit of shared pain, Republicans could begin by agreeing to a small fee on financial transactions that normally would make them blanch. In return, Democrats could pledge to limit increases in non-defense discretionary spending to inflation minus one percent, for five years. All it really requires is a burning desire by Republicans to hold on to the Bush tax cuts, matched by a heartfelt yearning by Democrats to preserve the jobs of as many public employees as possible. Who knows: If it works, it could be a first step towards a much broader agreement on serious, long-term deficit reduction.
Update, July 23: For more on this topic, please read the new NDN memo: Towards A New Economic Strategy - Steps We Can Take in 2010.
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