Nicholas Wapshott

Here’s the path around the fiscal cliff

Nicholas Wapshott
Dec 3, 2012 18:40 UTC

The “fiscal cliff” talks offer a chance to rebalance the American economy so that the long years of living beyond our means — spending too much and raising too little, paid for by borrowing from the Chinese – will be brought to an end in an orderly fashion. As we have seen from the pitched battle between the White House and the Republican House leadership, finding the right balance between tax increases and spending cuts is not easy.

The guiding principle for both sides, however, should be primum nil nocere: First, do no harm. Having survived the worst financial crash in 80 years, the United States should do nothing to put the fragile recovery at risk. Since the turmoil of 2008, economic growth remains positive but feeble, which is more than you can say for comparable economies, such as the eurozone and Britain, that have battened down the hatches and nosedived into slump. The 17 eurozone countries are deep in recession with joblessness at more than 11 per cent; last quarter the U.K. briefly emerged from a double-dip recession of its own making but is expected to enter a triple-dip recession by the end of the year.

If we get the fiscal cliff bargain wrong–too-large tax increases combined with too-deep, too-early cuts in public spending–we risk tipping the economy back into the painful recession we have just escaped. In Washington, the trade-ff between tax and spending is portrayed as a quid pro quo, with Democrats demanding tax cuts for everyone except high earners and Republicans pressing for deep cuts in Medicare but not defense. The politicians have badly framed the argument. Think of tax and spending — if you will excuse the battered simile — as the knobs on an Etch-A-Sketch. To draw a perfect circle entails turning both knobs together at exactly the right rate.

What if we fall over the fiscal cliff? Under the terms of the sequestration patch concocted last year, come Jan 1, if no deal is reached, $607 billion in tax increases and spending cuts will take effect, draining 4 percent of GDP with no tangible benefit. That would be a disaster. If tax cuts are not extended, demand in the economy will slump, businesses will falter or go bust, workers will be laid off, public spending on the unemployed and their families will increase, public borrowing will rise, and there will be a swift return to recession. Similarly, if public-sector spending is reduced too rapidly, demand will be sharply reduced, thousands of public service workers will be fired and paid unemployment benefits, public borrowing will rise and the economy will tip into recession. As Britain’s self-defeating austerity experiment is demonstrating, government-imposed misery in the name of paying off public debt can lead to increased public debt.

So, what is the way out? The trick is to boost the economy through tax breaks while making a start on addressing our long-term debt problems without cutting so soon and so deeply that the economy stalls. Think of a car with a manual gearbox starting on a hill. By gently pressing on the gas while easing in the clutch, the car smoothly climbs. A little too much on the gas or an abrupt use of the clutch and the car makes a series of unpredictable jolts and lurches that ends in the engine straining, spluttering, then stopping dead.

A lost chance to overturn Keynes with the fiscal cliff

Nicholas Wapshott
Nov 9, 2012 23:27 UTC

If free-market economists were serious about their ideas, they would surely be arguing vociferously right now for the economy to plunge over the fiscal cliff. But where are the laissez-faire economists lining up to urge John Boehner to lead his Tea Party tribe in the House to veto all compromise and put our money where their mouths are? They are strangely silent. Instead, the debate is about how Keynesian we should be.

A reminder for those who haven’t read John Maynard Keynes lately, or who have never read Keynes but oppose him anyway out of principle, he was a British math whiz who transformed economics forever with the publication of his “General Theory” in 1936. It suggested three ways to put wind in the sails of an economy in the doldrums. The problem, Keynes suggested, was that there was not enough demand for goods and services, and that governments should take a lead in stimulating spending to encourage business leaders to invest and create jobs.

Keynes’s first prescription was for central banks to make borrowing as cheap as possible with low interest rates. This deters saving and makes new investment in business activity more attractive. Businesses will employ workers who go out and spend their earnings. After studying the roots of the Great Depression, Milton Friedman and Anna Schwarz blamed the economic slump on money being too tight for too long. Such was the fear of returning to the deflationary devastation of the 1930s that successive Federal Reserve chairmen have taken this lesson to heart. Faced with a recession in 2001, even Alan Greenspan, a lover of the free market who flirted in his youth with the Lioness of Laissez-Faire, Ayn Rand, kept money rock-bottom cheap for the whole of the first decade of this century.