Politics Explained: Why Is Washington Trying to Solve a Non-Existent Problem?

If you’ve been following politics at all since the election, you’ve almost certainly heard about the need for structured deficit reduction legislation to avoid the upcoming “fiscal cliff”. The cliff is a combination of expiring tax cuts, such as the Bush tax cuts and the payroll tax cuts, and discretionary spending cuts between the military and non-military budgets. Essentially, on January 1, taxes will go up a lot and government spending will go down a lot, unless Congress and President Barack Obama do something about it. However, any solution is almost guaranteed to be a combination of tax hikes and spending cuts anyway. Is this right? I don’t think so.

Both Republicans and Democrats cite deficit reduction as necessary in order get government spending under control again. And it’s true that in the long term, we’re running up unsustainable deficits. However, there are two reasons why this is the worst time to go about reducing our deficit.

First and foremost, the US is still recovering from the Great Recession that began almost five years ago. Economic improvement has been steady but slow in the past few years, a trend to be expected of systemic banking crises according to Harvard economists Carmen Reinhart and Kenneth Rogoff . Basic macroeconomics says that when the economy is underperforming long term potential output, the solution is a combination of tax cuts and increases in government spending. This is what the stimulus bill sought to achieve, and it prevented the US from falling into another Great Depression. While our economy is undoubtedly in better shape than it was four years ago, we are by no means back to normal economic conditions. The Congressional Budget Organization projects that if Congress does not adapt the tax hikes and spending cuts set to take place, real GDP will decline by 0.5 percent and unemployment will rise from 7.9 to 9.1 percent. Structured deficit reform would probably do less damage, but the last thing we need right now is a loss in economic productivity.

The second reason why this is a poor time for deficit reduction is that the United States can borrow money extremely cheaply right now. Real long term interest rates are currently negative; that is, investors are willing to buy government securities knowing that they will lose purchasing power in the long term. Given that our government can essentially get money for free right now, there is no need to worry about the potential for default in the short term.

Furthermore, it is a common misconception that America runs up deficits by borrowing heavily from China. For every dollar invested in America, Americans invest 89 cents abroad. Foreign investment is a key component of global capitalism and is a driver of growth in countries across the world. In light of this, it makes no sense for the Chinese to suddenly call in their loans, as it would hurt both the American and Chinese economies.

Paul Krugman has written extensively on why this is an austerity crisis and not a deficit crisis here, here, and on his blog. I strongly agree with him on the issue of the deficit, as he is the only public figure who appears to truly recognize that we’re still in a recession. When the economy is underperforming long-term output, the solution is tax cuts and stimulus spending. The current plans proposed by Democrats and Republicans following the election, which consist of some combination of capping deductions on the wealthy, expiration of the payroll tax cut, ending the Bush tax cuts for the top bracket, and cutting discretionary spending, will do exactly the opposite, and potentially push us back into recession. Given that unemployment just fell below 8 percent and annual growth is under 2 percent, such a plan would be devastating. Worst of all is that this is not a crisis caused by market conditions that are out of our control; this is an entirely politically induced crisis who’s origins lie in our representatives in Washington. There is a significant chance that these politicians  will needlessly destroy the American economy and the global economy in order to solve a non-existent problem.


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0 comments

  1. 0
    von mises says:

    I cannot believe that a professor or a student at Swarthmore can in any way suggest that this is “not the ideal time for deficit reduction”.
    Please, PLEASE, educate yourself a little bit, read Von Mises, understand what the true implications of the deficit are, and pay attention to the results of government spending (with Obama the world champion, followed by George W. Bush).
    And, next time, vote for someone like Ron Paul (what an incredibly missed opportunity).

    1. 0
      Sara '12 says:

      Reasons why I would never vote for Ron Paul:

      1. He believes that my thorough, first-class high school education, which prepared me extraordinarily well for Swarthmore, seeks to “indoctrinate US primary and secondary school students through its ‘universal curriculum’ for teaching global citizenship, peace studies and equality of world cultures” and is “infiltrating the American school system.” All IB diploma holders, beware.

      2. He thinks the US should withdraw from the UN.

      3. He wants to end natural born citizenship.

      4. This bill he sponsored is full of not great things, but two bits stand out: it would have abolished the Department of Education and would have prohibited “the expenditure of Federal funds to any organization which presents male or female homosexuality as an acceptable alternative life style or which suggest that it can be an acceptable life style.” No need to worry about schools, apparently, and no presenting people as people, either!

      5. He wants to go back to the gold standard, a policy even Milton Friedman deemed impractical.

      6. The Washington Post fact-checker concluded that regarding racist and homophobic newsletters printed by Ron Paul’s company, “The Texas congressman has to take responsibility for the newsletters that bear his name, or at least acknowledge negligence as the former head of the company that produced them. He earns three Pinocchios for failing to do so.”

      Please explain to me why not voting for a paranoid, racist, and homophobic candidate who isn’t interested in preserving public education, or in international cooperation, and who is interested in impractical economic policy is “an incredibly missed opportunity”.

  2. 0
    Jason E. says:

    I understand that illegal immigration is complex, but it is not as complex as the politicians in Washington want to make it appear. We support legal immigration. We oppose illegal immigration. To call those who oppose amnesty and illegal immigration bigots is beyond ridiculous! And if they cannot understand that, we need some new leaders in Washington. I think congress is trying to make this more complicated than it is to divide us further……….but I think both sides will hold firm-thoughts?

  3. 0
    Airstrip One Prole says:

    thx for this boring keynesian boilerplate, you may as well have not written the rest of the article and just linked to some krugman bs. i see they only let the best and the brightest into the halls of swarthmore

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