Finally, America is on the verge of a major step towards reducing its dangerous and long-term fiscal deficits. This was seen as impossible six months ago. But, a combination of growing public antipathy to deficits, and, in particular, fierce opposition to raising the federal debt limit this summer has changed the environment and put Congress into a bind. It must raise the debt ceiling to enable continued national borrowing and avoid a catastrophic default. So, for political protection, its members now want to deliver a simultaneous, large deficit reduction package. Negotiations focus on $1,000bn-$2,000bn of reduction over 10 years, against an August 2 deadline on the debt limit. It may occur at the midnight hour, but an agreement is likely.
But this impending agreement should include two additional features which, until recently, would have been unnecessary. The first concerns the year in which deficit reduction kicks in. Remember that it is, in theory, contractionary. This suggests that the start date should be deferred. Instead of immediate reductions, an effective date of 2013 makes more sense, in the expectation of a stronger economy. Second, the three one-year stimulus measures passed in last winter’s special Congressional session should be extended one more year. Continue reading »