Playing With Economic Fire

| Fri Jul. 2, 2010 12:48 PM EDT

If the United States reduces spending and cuts its budget deficit, will that restore consumer confidence and help economic growth? Well, it's worked before — in other countries, other eras, and under other circumstances than today's. Bruce Bartlett summarizes the historical record:

Thus it turns out that fiscal contraction isn’t really expansionary except under conditions that do not exist today, and only when complimented by policies the U.S. is not free to pursue. Inflation and interest rates are at historically low levels and are not going to fall much lower even if the deficit disappears. As noted earlier, the Fed has limited capacity for further easing, and we can’t really depreciate our currency because it floats, nor is there any country to which we could realistically raise our exports to any great extent. Moreover, just about every other country is trying desperately to increase their exports to stimulate growth and all can’t do so simultaneously.

This is not an experiment that's going to turn out well. Consumer spending isn't going to rise while unemployment is high and wages are stagnant. (Former Jeopardy! champ James Pethokoukis on today's employment news: "If workforce had not shrunk so dramatically, the unemployment rate would have risen to 9.9 percent. Yes, I did the math.") Nor are consumers likely to draw down their savings or increase their borrowing. Just the opposite, in fact. And businesses aren't going to increase investment as long as consumers are in the doldrums. All of this remains true regardless of the state of the deficit. So how exactly is fiscal austerity going to help the economy?

It's possible, I suppose, that the economy will recover strongly and a few years from now we'll all figure out the mechanism that made it happen. But I doubt it. We're playing with fire here.