The Guardian Unlimited, August 15, 2011
A front page story in Sunday’s New York Times gave the country the bad news. President Obama is no longer paying attention to economists and economics in designing economic policy. Instead, he will do what his campaign people tell him will get him re-elected, presumably by getting lots of money from Wall Street.
The article said that President Obama intends to focus on reducing government spending and cutting programs like Social Security and Medicare. This is in spite of the fact that:
"a wide range of economists say the administration should call for a new round of stimulus spending, as prescribed by mainstream economic theory, to create jobs and promote growth."
In other words, President Obama intends to ignore the path for getting the economy back to full employment that most economists advocate. Instead he is going to cut government spending because his chief of staff and former J.P. Morgan vice-president Bill Daley and his top campaign adviser David Plouffe both say this is a good idea.
While people are justified in having little respect for economists – almost the entire profession missed the $8 trillion housing bubble that crashed the U.S. economy – it is still scary to see that policy will be determined by people with no knowledge of economics whatsoever. After all, do Daley and Plouffe even have a theory as to how cutting government spending could help the economy?
There of course is a theory as to how budget cuts could boost growth. The theory is that lower deficits in the present and/or near future will reduce fears that government spending will be crowding out private economic activity. This would lead to lower interest rates. Lower interest rates will provide a boost to investment and consumption. Also, lower interest rates in the United States will make dollar assets less attractive to investors. This will cause the dollar to decline against other currencies, improving our trade balance.
However no part of this story makes sense in the current economic environment. U.S. interest rates are already at ridiculously low levels, with the 10-year Treasury rate falling below 2.2 percent in the wake of the recent euro crisis. Does anyone really believe that the rate will go much lower even with large cuts to the budget?
Furthermore, even if interest rates did fall, it is difficult to believe that it would have much impact on either investment or consumption. Investment is not very responsive to interest rates even in the best of times. It is extremely unlikely that firms will rush to buy new equipment even if interest rates were to take another large plunge, when most are still operating with vast amounts of excess capacity.
Consumers remain heavily indebted due to the collapse of house prices. Furthermore, the huge baby boom cohort is going to feel more need to save than ever with the government slashing their Social Security and Medicare benefits.
The trade side of the picture doesn’t look much better. The dollar continues to be a safe haven in uncertain times. Furthermore, China and other export-dependent countries care little about U.S. interest rates; they want to protect their markets in the United States. They are likely to keep the dollar from falling too much against their currencies no matter how low interest rates fall. For these reasons, it is unlikely that cutbacks in government spending will do much to lower the dollar and reduce the trade deficit.
These would be the points that economists would make if President Obama was still paying attention to them. If there are effective rebuttals within economics to these arguments, they are not easy to find.
But President Obama is apparently not listening to economists anymore, so he wouldn’t care in any case. Just as we have many politicians who ignore climatologists in the design of energy policy, and politicians who think that biology has no place in teaching the origins of species, we now have politicians who think that economics has no place in designing economic policy.
This could be viewed as comical, but tens of millions of lives stand to be ruined. Ever since Keynes, we have known how to bring an economy back to full employment after it has fallen into a slump. Keynes’ basic insights have been supported by a vast amount of economic research over the last seven decades. And, we have solid evidence showing that the limited stimulus pushed through by Obama in 2009 worked pretty much as predicted in generating growth and jobs. But evidence apparently doesn’t matter at the White House any more.