Paced by housing and energy, the U.S. recovery is likely to accelerate this year and budget deficit projections have declined as well. Unfortunately the European economy remains stagnant though there is some evidence that stimulative policies are gaining traction in Japan. Around the world the idea of “austerity” is fiercely debated. This all makes a reconsideration of the principles that should guide fiscal policy opportune. This requires recognizing that policies need to be set in light of economic circumstances.
The economics commentariat and no small part of the political debate in recent weeks has been consumed with the controversy surrounding the work of my Harvard colleagues (and friends) Carmen Reinhart and Ken Rogoff (RR). Their work had been widely interpreted as establishing that economic growth was likely to stagnate in a country once its government debt-to-GDP ratio exceeded 90 percent. Scholars at the University of Massachusetts have demonstrated and RR have acknowledged that they made a coding error that resulted in their omitting some relevant data in forming their results and also have noted that using updated data for several countries reduces substantially the strength of some of the statistical patterns they asserted. Issues have also arisen with respect to how RR weighted observations in forming the averages on which they base their conclusions.
With the release of the president’s budget, Washington has once again descended into partisan squabbling. There is in America today pervasive concern about the basic functioning of our democracy. Congress is viewed less favorably than ever before in the history of public opinion polling. Revulsion at political figures unable to reach agreement on measures that substantially reduce prospective budget deficits is widespread. Pundits and politicians alike condemn gridlock as angry movements like Occupy Wall Street and the Tea Party emerge on both sides of the political spectrum, and partisanship seems to become ever more pervasive.
Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policymakers in Europe far prefer engaging the United States on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.
There should be little disagreement across the political spectrum that growth and job creation remain America’s most serious national problem. Ahead of President Obama’s first State of the Union address of his second term, and further fiscal negotiations in Washington, America needs to rethink its priorities for economic policy.
Since the election, American public policy debate has been focused on prospective budget deficits and what can be done to reduce them. The concerns are in part economic, with a recognition that debts cannot be allowed, indefinitely, to grow faster than incomes and the capacity repay. And they have a heavy moral dimension with regard to this generation not unduly burdening our children. There is also an international and security dimension: The excessive buildup of debt would leave the United States vulnerable to foreign creditors and without the flexibility to respond to international emergencies.
Sooner or later the American tax code will be reformed — probably sooner. Raising revenue will be the main motivation, but at a time of sharply increasing economic polarization, issues of fairness will be prominent too. There are also legitimate concerns about the complexity of current tax rules and their adverse effects on the economy.
Writing on behalf of the Romney campaign, my friend Mike Boskin has responded to my column from last week that argued that in a number of areas of economic policy, President Obama has the superior vision. Boskin condemns what he refers to as “Obama debt” and argues that Governor Romney has a better plan that he asserts offers “a superior alternative of balanced budgets.” While I was not writing on behalf of the Obama campaign and my piece had a much broader focus than budget deficits, several responses are appropriate.
If the global economy was in trouble before the annual World Bank and IMF meetings in Tokyo this past weekend, it is hard to believe that it is now smooth sailing. Indeed, apart from the modest stimulus provided to the Japanese economy by all the official visitors to Tokyo, it’s not easy to see what of immediate value was accomplished.