The deficit hawks have
taken over the G20:
“Those countries with serious fiscal challenges need to
accelerate the pace of consolidation,” it added. “We welcome the
recent announcements by some countries to reduce their deficits in
2010 and strengthen their fiscal frameworks and institutions”.
These words were in marked contrast to the G20’s previous
communiqué from late April, which called for fiscal support to “be
maintained until the recovery is firmly driven by the private
sector and becomes more entrenched”.
It’s basically incredible that this is happening with
unemployment in the euro area still rising, and only slight labor
market progress in the US.
But don’t we need to worry about government debt? Yes — but
slashing spending while the economy is still deeply depressed is
both an extremely costly and quite ineffective way to reduce future
debt. Costly, because it depresses the economy further;
ineffective, because by depressing the economy, fiscal contraction
now reduces tax receipts. A rough estimate right now is that
cutting spending by 1 percent of GDP raises the unemployment rate
by .75 percent compared with what it would otherwise be, yet
reduces future debt by less than 0.5 percent of GDP.
The right thing, overwhelmingly, is to do things that will
reduce spending and/or raise revenue after the economy has
recovered — specifically, wait until after the economy is strong
enough that monetary policy can offset the contractionary effects
of fiscal austerity. But no: the deficit hawks want their cuts
while unemployment rates are still at near-record highs and
monetary policy is still hard up against the zero bound.
But what about Greece and all that? Look, right now sovereign
debt problems are taking place in countries with a very specific
problem: they’re part of the euro zone, AND they’re badly
overvalued thanks to huge capital inflows in the good years; as a
result they’re facing years of grinding deflation. Counties not in
that situation are not facing any pressure from the markets for
immediate cuts; as of this morning, 10-year bonds were yielding
3.51 in Britain, 3.21 in the US, 1.27 in Japan.
Yet the conventional wisdom now is that these countries must
nonetheless cut — not because the markets are currently demanding
it, not because it will make any noticeable difference to their
long-run fiscal prospects, but because we think that the markets
might demand it (even though they shouldn’t) sometime in the
future.
Utter folly posing as wisdom. Incredible.