Saturday, July 9, 2011

Should the govt tighten its belt just like uncle Carl??

One of the main headlines in the news continues to be the debt ceiling negotiations and the fact that the government needs to get its spending in line. While, yes, in the long term, the government needs to get its spending under control, it's not wise to do it while the economy is in a funk. Despite the fact that the recession officially ended about two years ago, things still aren't functioning normally. See here, here, and here for recent, grim news.

First, a chart from Paul Krugman on the difference in importance between the issues actually facing the country, and the issues being tackled by politicians. It's sort of nuts. While the economy hasn't actually been able to start digging its way out of the hole it's in, this isn't being addressed (see the red line above). What is being addressed is the country's debt issue. Getting back to our roots here as a personal finance blog, one of the general tenets of credit is that the lower risk of default you pose, the lower interest you'll pay on your debt. This works the same whether you're a sovereign nation or an office clerk. This makes sense. If one has a suspicion that, after loaning their money, they're not going to get all of it back, they'll charge a higher rate to make up for that risk. As you can see above, the interest the government is paying on its debt is at an all time low.

Recently, Obama in a radio address did the exact opposite of what the above chart would indicate one should do:
Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.
Okay, so there's the crux of the congressional priority misalignment, and it's disappointing that the president doesn't understand it, cause he's a smart guy. While it's wise for people to tighten their belts during uncertainty, when everyone does it it causes economic problems; obviously, if everyone avoids the mall, the stores won't sell stuff. This hurts the economy. It seems basic, but I repeat it because people don't seem to understand it. Now, the one entity that can spend money freely right now is the government (remember the 3% interest rates and the fact that there's a ton of infrastructure to upgrade). Upgrading infrastructure would create demand, as stuff would have to be purchased to build rail/roads/ports; people would be employed to build stuff, and they would spend their money on more stuff; and this is how a virtuous cycle brings us out of malaise. Jared Bernstein cites other reasons why Obama is wrong to make the govt/citizen comparison:
Here’s the gist: “The federal budget is just like a family budget, and we in government must tight our belts and live within our means just like families do.”... [I]t’s almost always used as an argument for cutting everything to the bone right away, and... it’s wrong.

First of all, it’s bass-akwards: when families are tightening their belts, the federal government is the one institution that can actually help the economy—and these belt-tightening families—by loosening its belt and running a deficit. That deficit should be temporary and should come down when the private economy climbs up off the mat....

But there’s another fundamental way in which this family budget analogy gets misused. Families borrow to make investments and to get over rough patches. They run deficits too. I went into pretty deep debt to finance college and grad school and I’m glad I did. The whole credit system is based on the fact that if we had to pay cash-as-we-go for everything, we’d seriously underinvest. And that’s true for families and governments—and yes, you can overdo the borrowing thing. But to flip too far the other way is equally dangerous.

So... discount those who want to use it as a hammer to insist on instant cuts.

When evaluating potential candidates for president over the next year and a half, it'll be very telling whether they explain some of this, or just toe the party line.

Paul Krugman here lays out why the government can get out of debt, by (temporarily) creating more debt. Ryan Avent is playfully called a shrill hippie, as he sensibly argues for more stimulus and calls Obama's comment above "profoundly uneconomic." The sad thing is that congressional missteps will lead to us all being less well-off than we could have been.


  1. I don't think Obama fails to understand anything about what you're saying. It's more like Obama wants to get re-elected and he knows what people think they want to hear right now. Either way, though, it's clearly a case of bad priorities--not misunderstanding.

  2. Wouldn't a vibrant economy greatly help his chances in 2012? By implementing austerity now, that's put in jeopardy.

  3. You're right, but people are short-sighted (especially when they're hungry), and politicians play to short-sightedness. They want results now, and politicians pander to that. That's why the priorities are bad. He's more concerned (as are all politicians) with getting re-elected than he is with solving problems, especially if it means that there won't be any immediate benefit that he can use in a re-election campaign.

  4. dear Thatch:

    I am growing increasingly concerned over market deregulation and would be interested in a blog on that...what are your views?

  5. Stein, I don't know much, but there was some recent news about capital reserves for the banks being changed. Perhaps that could be written up.