To be sure, budget deficits equal to 10 percent of GDP or more, which some countries, such as the United States and Britain, were running, couldn’t be sustained indefinitely. (Germany’s deficit was much smaller: less than 5 percent of GDP.) But the best way to bring down deficits is to get the economy going again, which leads to higher tax revenues and lower spending on unemployment benefits. Shifting to retrenchment in the form of major budget cuts during the early stages of a recovery would smack of the mistake that the second Roosevelt administration made in 1936–1937, when, giving in to Wall Street orthodoxy, it slashed spending and raised taxes to balance the budget, only to see the US economy plunge back into recession.
The economists advising President Obama tried to resist the shift toward austerity policies. In an article in the Financial Times last July, Lawrence Summers, the outgoing head of the National Economic Council, pointed out that reviving growth and reducing the deficit were complementary rather than competing objectives. “Reducing the spectre of prospective deficits will enhance near-term growth,” Summers wrote. “And ensuring adequate growth in the near term will reduce long-term deficits.” In September 2010, the US administration proposed another round of tax cuts and infrastructure spending. But as the midterm elections approached, this initiative went nowhere.
Without the original $787 billion stimulus program passed under Obama, the public finances and the overall economy would certainly have been even weaker. Persuading the public to take account of what might have happened is far from easy, however, and opinion polls showed that most Americans agreed with conservative economists who said that the stimulus program had failed. The economic arguments put forward against the stimulus, such as the claim that increases in government spending generate offsetting falls in private spending, were largely specious; but they jibed with the ordinary American’s feeling that many, if not most, tax dollars are wasted.
After the Republicans’ big gains in the midterm elections, the prospects for a second stimulus package seem grim. For the embattled White House, one option that has been mooted is to propose new measures in the lame-duck session of the 111th Congress, which sits until January 2011, and to invite the Senate Republicans to oppose them with a filibuster. For example, the President could continue to insist that the Bush tax cuts for the rich should be allowed to expire at the end of this year, and to propose offsetting that tax increase with a big cut in the payroll tax, which is a tax on jobs.
Another option, which might have a better chance of succeeding, would be to offer the Republicans a deal under which a new stimulus package—a combination of tax cuts and spending increases—would be coupled with a temporary extension of the Bush tax cuts. To say the least, the politics of any such arrangement, which would increase the budget deficit on a short-term basis, would be complicated.
One thing is clear, though: the economy needs more help. In the third quarter of 2010, the overall level of demand for goods and services produced in the United States expanded by just 0.6 percent on an annualized basis. (A surge in accumulation of inventories—goods prepared for sale that are still sitting in factories and stores—boosted the GDP growth rate to 2 percent.) In plain English, the economic recovery has faltered badly. Relying on Ben Bernanke and his colleagues at the Federal Reserve to get it going again is a very risky strategy—akin to asking the pilot of jetliner that has stalled in the middle of the Atlantic to fly the rest of the way on one engine. Things might just work out. But if the other engine can also be restarted—and it can be—why take the risk?
—November 10, 2010