Opinion

Lawrence Summers

The economics of austerity

Lawrence Summers
Jun 3, 2013 12:45 UTC

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.

A prudent government must over time seek to balance spending and revenue collection in a way that assures the sustainability of debts. To do otherwise leads to instability and needlessly slow growth and courts default and economic catastrophe. Equally, however, responsible fiscal policy requires recognizing that when economies are weak and movements in interest rates are constrained ‑ as has been the case in much of the industrial world in recent years ‑ changes in fiscal policy will have significant effects on economic activity that in turn will affect revenue collections and social support expenditures. In such circumstances, aggressive efforts to rapidly reduce budget deficits may actually backfire, as a contracting economy offsets any direct benefits.

It is a truism that deficit finance of government activity is not an alternative to tax finance or to supporting one form of spending by cutting back on another. It is only a means of deferring payment for government spending and, of course, because of interest on the debt, increasing the burden on taxpayers. A household or business cannot indefinitely increase its debt relative to its income without becoming insolvent, and neither can a government. There is no viable permanent option of spending without raising commensurate revenue.

It follows that in normal times there is no advantage to deficit policies. Public borrowing does not reduce ultimate tax burdens. It tends to crowd out private borrowing to finance growth and job-creating investment and foster international borrowing, which means an excess of imports over exports. Or the expectation of future tax increases may discourage private spending. While government spending or tax cutting financed by borrowing creates increased demand in the economy, the Federal Reserve can in normal times achieve this objective by adjusting base interest rates.

It was essentially this logic that drove the measures taken in the late 1980s and in the 1990s, usually on a bipartisan basis, to balance the budget. As a consequence of policy steps taken in 1990, 1993 and 1997, it was possible by the year 2000 for the Treasury to use surplus revenue to retire federal debt. Deficit reduction and the associated reduction in capital costs and increase in investment were important contributors to the nation’s strong economic performance during the 1990s, when productivity growth soared and the unemployment rate fell below 4 percent. Essentially, we enjoyed a virtuous circle in which reduced deficits led to lower capital costs and increased confidence, which led to more rapid growth, which further reduced deficits, which reinforced the cycle.

The U.S. must embrace a growth agenda

Lawrence Summers
Feb 11, 2013 13:06 UTC

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.

The U.S. economy grew at a rate of 1.5 percent in 2012. Last week, the independent Congressional Budget Office projected that growth will be only 1.4 percent during 2013 – and that unemployment will rise. While the CBO says that growth will accelerate in 2014 and beyond, it nonetheless predicts that unemployment will remain above 7 percent until 2016.

A weak economy and limited job creation make growth in middle-class incomes all but impossible, add pressure to budgets by restricting tax revenue and threaten essential private and public investments in education and innovation. Worse, they undermine the American example at a dangerous time in the world.

America has multiple deficits

Lawrence Summers
Jan 22, 2013 04:05 UTC

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.

While economic forecasts are uncertain, the great likelihood is that debts will rise relative to incomes in an unsustainable way over the next 15 years without further actions beyond those undertaken in the 2011 budget deal and the end of year agreement that averted a fall over the “fiscal cliff.” So even without the risk of self-inflicted catastrophes — like the possible failure to meet debt obligations or the shutting down of government — it is entirely appropriate for policy to focus on reducing prospective deficits.

Those who argue against a further concentration on prospective deficits on the grounds that – contingent on a forecast that assumes no recessions – the debt to gross domestic product ratio may stabilize for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.

The ‘Obama debt’ fallacy

Lawrence Summers
Nov 5, 2012 15:16 UTC

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.

First, Boskin is correct in noting that current budget deficits and rates of debt accumulation cannot be maintained indefinitely, and that stabilizing and ultimately reducing the debt-to-GDP ratio is important if all sorts of economic horrors are to be avoided. This is a point of agreement between the two candidates–not a basis for choosing between them.

Second, Boskin blames the current high level of deficits on President Obama’s policies, but that is hard to square with the facts. When President Clinton left office in 2001, we were paying down the national debt at the rate of several hundred billions of dollars a year with budget surpluses. Since that time the Bush administration moved the United States substantially into budget deficits with large tax cuts, major military commitments to wars in Iraq and Afghanistan and a new prescription drug entitlement ‑ all undertaken without offsetting expenditure reduction or increasing revenue. Beyond these decisions, the largest factor in the current level of deficits is the worst economic downturn since the Depression ‑ a downturn that began under President Bush. People will debate the merits of President Obama’s stimulus measures ‑ though I think their positive effect on growth and employment is quite clear ‑ but this debate matters little. Government employment has been contracting, and the debate over stimulus has largely faded.

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