Should the US launch a temporary fiscal push now?

By Francis Bator

Sir Andrew Large, former deputy governor of the Bank of England, advises the US to soon follow the UK example of fiscal surgery (in a letter to the FT on October 22). He appears to believe that the US too is “living beyond its means,” so “reductions in gross national product from… public spending cuts are inevitable”.

Not so, for the time being at least. True we continue to spend more on goods and services than we produce, importing more than we export to cover the difference ($539 bn/year in the second quarter = 3.75 per cent of gross domestic product). But we currently spend much less — and therefore produce much less — than our capacity to produce.

According to a recent front page Wall Street Journal Vital Signs:

“In the second quarter, gross domestic product came to just 93.5% of potential GDP – what the economy could produce without straining its currently available business capacity and labor force. Because that leaves little scope for firms to raise prices or for workers to command higher wages [the Journal adds,] the chances of inflation becoming a problem seem low.”

Estimates of potential output are of course uncertain. But that we face a huge, shortfall of demand is plain. As fastidious a student of the evidence as Professor Robert Hall, hardly a deficit “dove”, has been reliably reported as believing that “there is little to suggest that a rapid expansion of demand would not quickly restore full employment.”*

Fiscal choices should not depend on shouts of bond market wolf by distinguished emeritus central bankers abroad or in the US. The need is for explicit, risk-aware weighing of the waste and real long term damage caused by a huge, multi year output and employment gap. Versus one’s guess about how the financial markets might or might not react to a well explained, briefly deficit-enlarging fiscal push (and what the Federal Reserve and responsible foreign central banks could do about an irrational speculative binge).

In any case, it’s not “either/or”. Why not a temporary fiscal push now, together with a multi year Obama budget plan that would gradually put the debt to GDP ratio on a sustainable non-explosive track? With a mix of future spending cuts and tax increases that reflect an ongoing presidentially led national debate about how much of our GDP to keep diverting from valuable private use to specific kinds of valuable public investment and valuable public services, and to subsidized private consumption of people truly in need. The president should keep reminding us that, with a GDP per notional three-person family of $142,000 – a number depressed by the recession and likely to grow after a full recovery by 1.75 per cent – 2 per cent per annum — we are a very rich country. And that, for our children and grandchildren, the burden versus benefit of federal deficits now is likely to depend in large part on what we spend the money on, and on what use, if any, currently unemployed workers and idle capacity would otherwise be put.

We argue endlessly about taxes and government spending and deficits and debt in no relation to what real economic outcomes we want those policy instruments to achieve. Yet it’s those real outcomes that it’s really all about.

* General Discussion, March 19 Meeting, Brookings Papers, Spring 2010, p. 66.

Francis Bator is Littauer professor of political economy emeritus at the Harvard Kennedy School