off the charts
BEYOND THE NUMBERS
BEYOND THE NUMBERS
International Evidence Provides Poor Guide for U.S. Budget Policy
Joint Economic Committee (JEC) Republicans issued a report last week arguing that cutting government spending is the key to both long-run fiscal stability and economic growth — and that the sooner we start down that path, the better. The paper cites empirical evidence concerning deficit-reduction efforts in numerous countries over the past several decades that, at first glance, seems to support their claim. But, in reality, this evidence has little relevance to the fiscal and economic challenges facing U.S. policymakers. The United States faces the short- to intermediate-term challenge of recovering from its greatest economic slump since the Great Depression. Our chart book documents the substantial economic slack and excess unemployment that remain almost two years after the recession bottomed out. But the United States also faces the longer-run challenge of stabilizing the federal debt, which is on an unsustainable path. This long-term problem was evident before the recession hit, and the spike in the budget deficit due to the recession made little difference to the long-term problem. Federal Reserve Chairman Ben Bernanke has warned against an immediate, sharp reduction in federal spending, saying at a recent congressional hearing, “the cost to the recovery would outweigh the benefits in terms of fiscal discipline.” Emphasizing the importance of taking a long-term view, he said, “We need to show that we have a plan that will carry us forward for the next decade at least, that will produce consistent reductions in that deficit over time, and that has the benefit of allowing us to think it through.” The Republican JEC report reaches a different conclusion. It claims that “a growing body of empirical studies proves that fiscal consolidation programs based predominantly or entirely on government spending reductions are far more likely to be successful” at stabilizing deficits than programs based on tax increases [emphasis added]. The report argues that “quick, decisive government spending reductions” are a key to success and that deficit-reduction programs focusing on spending cuts “may even boost the real GDP growth rate in the short term under certain circumstances.” The studies on which the Republican JEC report is based, most prominently one by Harvard economists Alberto Alesina and Sylvia Ardagna, examine disparate countries facing disparate economic and budget situations under disparate global economic conditions. Their limitations deserve much greater scrutiny. We are preparing a fuller analysis, but here are three preliminary observations:
- Evidence that cutting spending increases GDP in the short term is weak. The International Monetary Fund has concluded with regard to Alesina and Ardagna’s study, “The idea that fiscal austerity triggers faster growth in the short term finds little support in the data.”
- Evidence that a deficit-reduction program focused on spending cuts can promote short-term growth and long-term fiscal stability is slim. Alesina and Ardagna identified 107 episodes of “large” deficit-reduction programs. Among these, we count only nine that they characterized as both “successful” (i.e., the program stabilized the debt) and “expansionary” (i.e., it did not harm economic growth in the short term). All nine occurred in small, mainly Scandinavian economies: Finland, Ireland, the Netherlands, New Zealand, Norway, and Sweden.
- U.S. macroeconomic and budget conditions aren’t right for sharp spending cuts. Mike Konczal and Arjun Jayadev examined the specific episodes Alesina and Ardagna cited in which spending cuts boosted short-term growth. They found that none of them took place in a country still feeling the effects of a large recession as the United States is now, with substantial economic slack, tepid economic growth, and high unemployment.
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