Progressives and the Budget Deficit

The budget situation today
looks hugely worse than it did two years ago. The reason for the
deterioration is not that the country has suddenly embarked on a
massive new round of social spending, undertaken another major military
adventure or even emptied the coffers through tax breaks. The reason
that the deficit situation looks hugely worse than it did two years ago
is that the $8 trillion housing bubble that had been driving the
economy finally collapsed and threw the country into the worst downturn
since the Great Depression.

The tragedy in this story is that the collapse of the bubble and
its devastating consequences were entirely predictable. Had
policymakers recognized the housing bubble and its dangers, they could
have easily taken measures to avert this disaster, preventing the surge
in unemployment, the flood of foreclosures and the huge budget deficits
that characterize this downturn.

Unfortunately, the sociology of the economics profession and
economic policy-making is structured so that the voices of those who
raised concerns about the housing bubble were largely excluded from
public debate. Federal Reserve Board Chairman Alan Greenspan and other
leading lights of the economics profession insisted that everything was
fine. As a result, nearly all the properly credentialed "experts"
marched in lockstep behind their leaders, also insisting that
everything was fine.

Remarkably, even after this collapse, nothing has changed in the
structure of debates over economic policy. Nearly every day of the week
an organization in Washington sponsors a policy session on the budget
deficit or some other important economic topic and every last "expert"
is among that distinguished group that somehow could not see an $8
trillion housing bubble.

This would be like hosting a session on the future of US military
involvement in Iraq in which every participant had confidently
predicted in 2003 that the United States would cakewalk to an easy
victory. Even the Republicans wouldn't be foolish enough to host a
panel like this. Yet, there seems to be a bipartisan consensus that
completely missing the biggest economic calamity in almost 80 years
doesn't call into question your competence as an economic analyst.

This should scare people. There is no reason to believe that people
who were incapable if independent analysis before the bubble collapsed
are now capable of thinking for themselves. In other words, the vast
majority of the so-called experts who pontificate on economic policy
are still people who are more accustomed to deferring to authority than
doing their own analysis. This means that a great deal of silliness is
likely to be perpetuated, just as was the case before the housing
bubble collapsed.

The basic story on the budget deficit is very simple: We need badly
need large budget deficits in the short term. They are the only force
that can sustain demand in the economy after the collapse of housing
construction and the loss of the consumption that had been supported by
$8 trillion in illusory housing bubble wealth.

In the longer term, we will need to reduce our trade deficit to
replace this demand, but this can only be brought about by a reduction
in the value of the dollar against the currencies of our trading
partners. If our budget experts had been capable of independent
thinking before the crash, they would have pointed out the over-valued
dollar as a main cause of imbalances in the US economy. Unfortunately,
most of them are still incapable of recognizing the obvious.

The other big oversight that the budget experts commit is the
failure to recognize the positive role that moderate rates of inflation
can play in our economic recovery. Sustained inflation in the range of
3 to 4 percent will be the quickest way to rebuild the balance sheets
of households who saw most or all of their wealth disappear with the
bursting of the bubble.

Modest inflation will also help to erode the debt burden the
government was forced to take on due to the housing crash. For those
old enough to remember, inflation was also a major factor in reducing
the burden of the huge debt that the country incurred as a result of
World War II.

Of course in the long term, if we don't fix health care then the
deficits will be unbearable, but this calls for discussions of health
care, not budget deficits. If we don't fix health care, the economy
will be wrecked regardless of what we do with the budget.

But, we won't get a more serious discussion of these issues until
we have budget experts who actually form independent assessments of the
economy. As it stands, the debate is dominated by a follow-the-leader
crew who could not see an $8 trillion housing bubble.