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Weak Economy, Wrong Debate
What is it with this economy? The Dow hits 14,000, the unemployment rate rises in January, and GDP actually falls in the last three months of 2012. Could it be that what's good for the stock market is bad for the rest of the economy? Could it be that captains of industry like weak labor markets, high unemployment, low wages -- and a Federal Reserve that has to use ultra-low interest rates to try to keep things afloat?
Well, yes, but the story is also richer and more complicated.
Basically, the economy is still weighted down by the legacy effects of the financial collapse of 2008 -- mortgages that exceed the value of homes, students staggering under the weight of college loans in a dismal job market, retired people for whom low interest rates mean low returns on savings, corporations looting pensions, and above all flat or declining wages.
It all adds up to a very weak recovery -- but the common element is insufficient purchasing power on the part of ordinary families. And this is about to be compounded by Fiscal Cliff II, namely Congress and the president deciding that what the economy really needs is a bracing dose of deflationary budget cuts.
What exactly happened in the last quarter of 2012 to cause the recovery not just to stall -- but to actually shrink the economy by a tenth of a point? According to the Commerce Department, there were multiple factors.
Exports slumped, business purchases to replenish inventory slowed, but here is the sentence that screams out: "Real federal government consumption expenditures and gross investment decreased 15.0 percent in the fourth quarter, in contrast to an increase of 9.5 percent in the third." In other words, cut government spending and you undermine a fragile recovery.
There was a little good news amid the bad news. Revised numbers indicate that the economy generated jobs in 2012 at a rate of about 32,000 a month more than first reported. But hidden unemployment -- part timers not finding full-time jobs -- rose again in January and wages have remained basically flat. The economy's gains still go mainly to the very top.
Seemingly, President Obama has moved off the deficit-hawk kick that marked his posture in 2010 when he appointed the Bowles-Simpson Commission, and 2011 when he agreed to a budget deal with massive cuts and automatic triggers adding up to about $4 trillion in deficit cuts over a decade.
Seemingly, too, the corporate-led "Fix the Debt Campaign" -- millionaires and billionaires telling the rest of America to tighten its belt for the greater good -- isn't getting a great deal of traction. Our friend Paul Krugman last week wrote a column, "Deficit Hawks Down," saying that we should pity this crowd -- for all the money they've spent, they keep being contradicted by events.
But despite the sheer unreality of their claims, the austerity lobby keeps winning by defining the terms of debate. Nearly everyone, right, center and left, is arguing about the economic recovery in terms of what the debt-to-GDP ratio should be in 2023.
That is the wrong question. The right question is: how do we get a stronger recovery going now? With robust growth, especially of wages, the debt ratio will come down. Excessive budget cutting in a depressed economy slows growth and worsens the debt ratio, but with the exception of Krugman, Joseph Stiglitz, and your faithful blogger, that's not a point widely made in the debate. (Let's also credit Jamie Galbraith, Bob Reich, Larry Mishel and Dean Baker.)
But our gang doesn't get invited into the rooms where deals are cut, and isn't having much influence on what passes for debate among what Krugman calls Very Serious People, namely the debate among Obama, the Republicans, the Wall Streeters, and the suite of deficit-hawk lobbies underwritten by billionaire Pete Peterson.
In 1945, the debt ratio was much larger than today -- 120 percent of GDP versus today's 72 percent. But anyone in 1945 urging that the main economic issue was the debt ratio in 1955 would have been laughed out of town. The main issue was how to re-employ 12 million returning G.I.s
Yet consider what passes for debate today.
President Obama, newly in deficit-dove mode, declares that we have achieved so much deficit reduction that we need "only" about another $1.5 trillion in deficit reduction over a decade to stabilize the debt-to-GDP ratio by 2022. Obama's budget actually cuts net public investment to achieve that goal. It cuts public investment!
Then, the center-left Center on Budget and Policy Priorities re-calculates the numbers, and pronounces that it will really take "only" $1.2 trillion in deficit cuts over a decade (counting saved interest costs) to stabilize the debt ratio.
Whoopee, only $120 billion a year in budget cuts a year and we hit the target.
And then the progressive EPI re-computes the data yet again, and figures that we can get to the holy grail of a stable debt ratio with only $670 billion in further deficit cuts -- and very helpfully challenges the entire premise that deficit reduction is the road to recovery.
Uh-oh -- the center-right is not amused.
The Pete-Peterson-funded Committee for a Responsible Federal Budget takes offense and warns that we really need another $2.2 trillion in new deficit cuts.
Rudy Penner, director of the CBO in the Reagan era, declares stabilizing the debt ratio at its current level of about 70 percent is not enough.
In this priceless twist of economic logic, Penner warns:
"Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022."
Yes indeed, Rudy, if we listen to folks like you and follow a fiscal policy of slash-and-burn, we are guaranteed to have another slump between now and 2022 -- quite possibly a continuing slump for the entire decade.
People: this is the wrong debate. Has any of these worthies taken a macro-economics course? If you slow down growth by excessive belt-tightening, tax revenues fall and the deficit goes up. You can't just assume that very dollar of deficit reduction equals a dollar credited to reduction of the debt ratio.
For budget wonks, this very useful piece by EPI's Ethan Pollack lays it all out.
President Obama should read every word of this.
In what passes for the debate about the budget and the economy, two other details keep being overlooked: The main driver of rising deficits over the long term is Medicare. You fix Medicare by reforming the larger health system of which it is a part, not by sandbagging the rest of the budget and economy.
And speaking of economic contraction, one other key item somehow got lost in the shuffle. As part of President Obama's tax deal with House Speaker John Boehner raising taxes "only" on the richest one percent, America's working people got a big tax increase when both parties agreed to let the two-point cut in the payroll tax expire.
So since January 1, wage and salary workers have had two percent less income to spend. That's a huge hit -- as if every American worker suddenly took a two percent pay cut. The tax deal amounted to a big tax increase on the bottom 99 -- terrible policy distributively, terrible policy macro-economically.
(Some liberals worried about the drain of the two-point tax break on the Social Security trust funds, but that money should be made whole by transfers from general revenue; reducing the burden of the regressive payroll tax was a huge gain for progressivity.)
In sum: unless we stop obsessing on cutting the debt ratio as an end in itself, we are condemned to a decade of economic underperformance.
President Obama got some nice political lift from his re-election and his new, more assertive tone. But he (and the economy) are still dragged down by the undertow of bad economic assumptions that continue to contour the debate.