Navigating troubling economic waters

July 12, 2011

3-minute read

Down south, the Obama administration is in a dangerous game of chicken with Republican congressional leaders, who are cynically holding the US economy hostage in order to impose a radical agenda of spending cuts. Obama has seemingly bought into the rhetoric of cutting debt, rather than focusing on the real US problem of unemployment. Yet, even his foolish offer to make cuts to Social Security and Medicare as part of a deal to raise the debt ceiling have been rejected by the Republicans (military spending cuts are off limits to them as are any tax increases).

Having caved on extending the Bush upper-income tax cuts last year, the Republicans are betting Obama will cave again. Let's hope he doesn't because the biggest threat facing the global economy right now is that self-inflicted austerity programs implemented in Canada, the US, the EU and elsewhere push us back into recession, and that would increase unemployment and further deepen financial problems.

At heart is the faulty premise that fiscal austerity is needed in order to shore up business confidence so that they will invest and thus grow the economy. Paul Krugman calls this the "confidence fairy" and it is clear from case after case worldwide that there is no such fairy. Austerity in the midst of an economic downturn makes things worse by undermining employment and the economy, worsening not improving the government's fiscal situation. It is the modern equivalent of human sacrifice.

Joseph Stiglitz remarks:

Regrettably, the financial markets and right-wing economists have gotten the problem exactly backwards: they believe that austerity produces confidence, and that confidence will produce growth. But austerity undermines growth, worsening the government’s fiscal position, or at least yielding less improvement than austerity’s advocates promise. On both counts, confidence is undermined, and a downward spiral is set in motion.
In the case of both Stiglitz and Krugman, it is nice to seem them sticking to solid Keynesian economics when so many business commentators and politicians have abandoned economic reality. It is a key role of government to stimulate the economy when it is depressed, and that means more effort at job creation not less. The biggest mental error I see out there is the notion that governments are like households and must tighten their belts, which is precisely the wrong way of thinking about things in macroeconomic terms.

In the case of the US, part of the problem is that Obama was not stimulative enough, with fiscal policy consisting largely of tax cuts (a weak stimulus particularly when aimed at the wealthy) and aid to the states (which is necessarily to plug holes but not truly stimulative). One result of tax cuts is that they have simply padded the coffers of big corporations. Like in Canada, US corporations are sitting on a hoard of cash -- investment is not happening because it is customers that are lacking, not confidence.

Some historical context is needed, too. The Bush era tax cuts and spending to wage war converted budget surpluses a decade ago into the baseline deficits heading into the recession. Republicans seemed to have no qualms about rising debt back then. The US economy is still fragile with high unemployment and the lingering fallout of the housing bubble collapse. Deficits and extraordinary monetary policy have averted an outright depression, but at the moment any lessons from the financial crisis of a couple years ago have been lost to a resurgence free market fundamentalism.

What's this mean moving forward? Keeping up the stimulus is a top priority, and even leaning more heavily into job creation would be advised. If deficits are of concern, then increase corporate taxes and income taxes on the wealthy. Engage mortgage relief to the millions of US households who are underwater. But don't buy into the doom and gloom stories about default. While it is true that a default would be uncharted territory, constitutionally, US debt is backed by law. The US issues debt in a currency it controls, and the Fed could play a major role by buying up some of the outstanding debt for cash. But ultimately, as James Galbraith points out, the big holder of US debt is China and it does not really have anywhere else to go to park its money (some gold, Swiss francs and some Canadian dollars on the margin perhaps).

For Canada, this means we need to keep our cool, and NOT play the austerity game revealed in last month's budget. Piling on with spending cuts and layoffs will only make things worse. Federally and provincially, governments need to focus on employment not deficits in order to maintain robust demand in the economy (climate action is a great place to start). The Bank of Canada also needs to reconsider murmurings of interest rate increases this fall in light of these developments. Our biggest risk is that we harm ourselves to save a summary statistic rather than focus on the real challenges.

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