Macro Confusion

I doubt I have ever seen a time when there was so much confusion about macro and policy. I recall being a teaching assistant for Professor Benavie at UNC in 1973 when a student streaked naked through his macro class of 300 freshmen. That was pretty confusing. Benavie was quite a pro. As I recall he made an offhand gesture about the color of the guy’s ski mask and went on talking about GDP.

I wish things were that easy right now. I hardly know where to begin so perhaps a tiny sip of JD will get me headed in the right direction. Okay. The main confusion comes, I think, because macroeconomic policy has several goals. One goal is long-run oriented – to keep the capacity of production and employment growing. A second goal is short-run oriented – to keep current output very close to or at capacity. A third goal is to use policy in such a way that you are able to pay for whatever macro policies you employ.

As you know, the federal government’s macroeconomic policy following the recession in 2008 was to stimulate demand and production. Recessionary conditions meant people were not spending enough. The government created massive fiscal deficits as a means to replace or offset the missing private spending.  Tax cuts and government spending increases were used towards that end. A very expansionary monetary policy was used by the Fed to supplement the government’s attempt to bring weak demand and output back to capacity.

By 2012 the economy was beyond the end of the recession but recovering very slowly. In such times we would normally begin to reduce the amount of short-run policy stimulation. Furthermore after several years of very large government deficits, most politicians agreed that our financial stability and our economic recovery were threatened by rapidly growing federal government debt.  As such politicians set out to find a policy that would address this debt problem. One only has to look at recent history in Europe to know how damaging a debt problem can be to a country. Of course, one can look at Europe and also see how politics can come into play when one has to be specific about the tax increases and spending reductions that would compose such a policy.

Despite wide agreement about the urgency of a deficit reduction plan, no progress was made. So US politicians made a contract with the devil. They agreed on a very extreme austerity program that would automatically raise taxes and reduce spending harshly. It was one way to solve the looming debt problem, albeit an extreme one.

But such austerity clashed with the short-run goal of strengthening the economy. Why? Because such an extreme and fast solution for the debt would knock the wind out of the economy. The plan, of course, gave politicians most of 2012 to come up with a more reasonable way to solve the debt crisis. Please underline something there – the idea was to give them more time to come up with a way to resolve the debt problem.

And here is where the confusion comes in. The government did do something toward the end of 2012 and the first few days of 2013. It was heralded as an historic compromise. It did manage to avert at least partially the phony fiscal cliff they had created. But please note – the purpose of the fiscal cliff and the policies debated all year were aimed at reducing national debt. So what was this great historic agreement? It was an agreement to increase the US national debt by another $1.5 trillion between now and 2017. The debt was already going to increase by $1.7 trillion in those five years – so with the new legislation passed it will instead increase by $3.2 trillion. Already financial experts are predicting a downgrade of US debt. We had more than a year to deal with an explosive debt issue and our government dealt with it by making it larger.

So why would our government behave in this way? I have some possible answers but maybe you do too. So don’t be bashful.

First, these policies to balance the budget appear to be at odds with an economy that has never truly burst out of the last recession. Some people fear that external factors might impact us later this year and push us back into a recession.  I share that concern. But making the debt problem worse right now is no way to strengthen our economy. 

We did not have to accept the drastic tax and spending changes of the fiscal cliff to improve tax revenues and expenditures over the coming five years. We could have gradually implemented a government spending slowdown and an increase in taxes.

Second, they promised to work on the fiscal deficit between January and March of this year. Really! They couldn’t do anything in years about the deficit and we are to believe they are going to do it in two months?  

Third, since the agreed solution was almost totally focused on increasing taxes there was a belief that the coming solution – and one that might address the national debt – would be focused on slowing government spending. But already some politicians say they want more balance with respect to taxes and spending.  The fear is that this is simply code for raising taxes on the wealthy. There are still many politicians who say we cannot remove a penny from Social Security, Medicare or Medicaid. In all, it is hard to see how we will reduce the nation’s debt. 

The most probable path is one where we continue to have macro confusion. It is a path that talks about debt but ignores it in favor of short-term stimulation. It is a path where income redistribution is paramount as we focus on policies to raise taxes on the rich while leaving sacrosanct spending for everyone else.  The sad thing is that this path will do little to prevent a second recession; will do very little to help the middle class; and will do a lot to keep debt high and economic growth low. This is no way to run a country.