The economic policy debate in Washington has come down to a boxing match between two opposing remedies – ‘stimulus’ in one corner and ‘austerity’ in the other. Unfortunately, considering each so-called solution in isolation has hampered both analysis and decision-making. The proponents of stimulus argue that the losses in aggregate demand following the global financial crisis must be reversed. Their opponents say that austerity is needed to restore fiscal sustainability. But to understand how elements of each fit together, a different approach is needed, one that integrates the sets of economic logic and data employed by the two sides.
There are three tangible steps to boost growth. First, fundamental tax reform is essential, as is a viable plan for medium and long-term fiscal consolidation. Lastly, policy actions must make it easier for households and businesses to respond positively to fiscal stimulus or to low interest rates.
These seemingly disparate steps come into focus as one connects the dots in the causes of sluggish US economic growth. Taken together, they could improve growth sufficiently to bring the unemployment rate back to pre-crisis levels within four years. Otherwise, the debate we are having about stimulus versus austerity risks being as futile as rearranging the deck chairs on the Titanic.