Deficit reduction is not the enemy of jobs

Jared Bernstein in the Financial Times:

When the economy gets back up to speed, the key to debt reduction in the US will once again be paying for federal spending in real-time, and dealing with rising health costs. That is why our recent health care reforms target unsustainable health costs, and old “PAYGO” rules that require Congress to pay for new entitlement spending or tax cuts in normal times have been reinstated.

Yet policymakers should know that a dollar spent by the government today adds less to the deficit than a dollar spent when the economy is at full strength. In normal times, deficit spending is like adding water to a glass that is already full. Public spending just displaces private. Even if deficit spending did add to the glass, the Fed would avoid the spill by jacking up interest rates. We’d be creating more debt for no good reason.

But when you have so many people out of work – so much extra capacity – the outcome is different. As economist Brad DeLong recently noted, at times like this “there is no crowding out of private investment; on the contrary, there is likely to be crowding in”. We saw just this in our 2009 Recovery Act, which is using matching grants and tax credits to encourage private investors to come off the sidelines and finance the expansion of new industries – and new jobs – most often associated with clean energy. The existence of all this excess capacity keeps interest rates and inflation low, so monetary policy is not compelled to mop up any overflow.

Such short-term, temporary spending does not add to medium- or long-term debt burdens. Spending that gets into the system, acting to offset a collapse in private demand, and then scaling back as the private sector comes back online, has only a minor impact on longer-term debt.

At $787bn, the Recovery Act is far larger than any of the new targeted stimulus jobs programmes the president is now proposing. Even a programme of this magnitude adds less than a half a per cent to the deficit-to-GDP-ratio by 2012, and nothing to the growth in the debt-to-GDP ratio for the rest of the decade.

These economic relationships are not unknown, so why is it proving so hard to pass legislation related to temporary jobs measures? One reason may be that members of Congress believe that, since the worst is over, now is the time to hand the growth baton back to the private sector. This is the same mistake made in the late 1930s, when it threw the country back into depression.

Compared to the size and scope of the Recovery Act, our new proposals reduce the magnitude of spending programmes needed to keep up economic momentum. But with millions desperately needing to get back to work, it is too soon to give up, especially given the favourable debt trade-offs that are unique to this moment.

It would be wrong to overstate this friendship between job growth and deficit reduction: this is not an argument for a free lunch. But as President Barack Obama recently pointed out in a letter to our Congressional leadership, today’s conditions mean the real cost of helping to preserve important jobs is now as much as 40 per cent below the budgetary cost.

Equally important, Mr Obama used the letter to list steps that will lead us back to fiscal health once the economy recovers. These include the reduction of temporary programmes, spending freezes and reductions, a fee on big banks and, most importantly for the long run, implementing health reform.

Thankfully, we do not have too many moments when unused capacity creates a friendship between growth and deficits. But if we fail to recognise this one, we risk unnecessarily condemning millions of American families to pain that could, should and must be avoided.

Posted via email from Jim Nichols