Economic Intelligence (U.S. News & World Report), February 10, 2012
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It's budget time, and that means that we can expect to hear the Washington elite wailing about the budget deficit for the next several weeks. When hearing the cries about out-of-control deficits, people would be best advised to turn off their television sets, put down their newspaper, and smash their computers. (Okay, don't smash your computer.)
The economy has one major problem right now and that is a serious lack of jobs. We still have more than 25 million people unemployed, underemployed, or who have given up looking for work altogether because there are no jobs. This should be the issue that everyone in Washington is talking about.
Instead, many politicians and pundits want to distract people's attention from unemployment by complaining about the deficit. They have deceived many people into thinking that the economy would somehow be stronger and there would be more jobs if the deficit was reduced, either due to spending cuts or increased taxes.
This view makes no sense. There are no businesses that are going to hire additional workers because the government laid off school teachers or firefighters and we cut back spending on food stamps. Businesses hire more workers when they see more demand for their product. All of these actions that reduce the deficit, either on the spending or tax side, translate into less demand and therefore less employment. In short, those who want to cut the deficit now are lobbying for fewer jobs and higher unemployment.
This is only part of the story that they got wrong. The other part is the cause of the deficit. There are thousands of people running around Washington blaming the deficit on out-of-control spending or irresponsible tax cuts. Both sides are way off the mark.
It is easy show from the data that the huge deficits of the last three years are the direct result of the economic plunge caused by the collapse of the housing bubble. The budget deficit was actually quite modest in 2007, and it was projected to remain low in 2008-2010, even before the Bush era tax cuts expired.
However, the deficits came in much higher than projected because the collapse of the economy sent unemployment soaring and tax revenues plummeting. There is an irony in this situation. Back in the years 2002-2007 some of us were warning about the housing bubble, but our voices were largely drowned out by the big deficit hawks.
Of course now that the bubble has collapsed and the deficit has exploded we are still hearing the same complaints from the deficit hawks. If the country had paid less attention to the deficit hawks back in the bubble years, and more attention to the bubble, then we would not have had such a horrible recession and the deficit hawks would not have a large budget deficit to complain about today.