Cut government spending and grow? I say no.
Neil Irwin鈥檚 WaPo this AM provides a useful review of the different ways economists and politicians are thinking about the short-term impact of spending cuts on growth and jobs.
I鈥檝e been pretty aghast to hear claims that large cuts would immediately generate job growth (and Irwin should have at least quoted someone with that view in the piece) when the opposite is almost surely the case. You can make this a lot more complicated, but when you鈥檙e as far below capacity as we are鈥攚hen so many people are unemployed, e.g.鈥攊t鈥檚 really quite simple arithmetic. Government spending feeds right into GDP growth and cuts subtract from it.
Now, when you鈥檙e at full capacity, it鈥檚 different. At that point you鈥檙e pouring water into a glass that鈥檚 already full so you鈥檙e just wasting water. And you鈥檙e going to need some paper towels to clean it up (that鈥檚 inflation in this example鈥攕orry, it鈥檚 early and I鈥檓 only partially caffeinated).
But with GDP growth just around trend (positive but not all that strong) factories with capacity to spare, and 20+ million un- or underemployed, there鈥檚 space in the glass. In fact, if you look at the GDP or employment accounts, it鈥檚 clear that state spending contractions are a real drag on growth and jobs right now. (Maybe I鈥檒l try to post some graphs on this later.)
If I ran the country and had my druthers and wasn鈥檛 constrained by today鈥檚 budget politics (yes, that鈥檚 a lot of 鈥榠fs鈥�), I鈥檇 do another round of state fiscal relief.
The story the 鈥渃ut-now-and-grow鈥� lobby wants to tell depends not on arithmetic, but on what Krugman calls the (she鈥檚 good) and the crowding-out troll (he鈥檚 bad). In a tight budget environment like today鈥檚, politicians love the fairy because she provides free stimulus. And since she鈥檚 a fantasy, you can attribute anything you want to her: 鈥渃onfidence in the markets depends on [your favorite budget cut here]!!鈥�
Then there鈥檚 the notion that high public spending levels are crowding out private borrowing. Again, not a plausible story with excess capacity, the Fed funds rate at zero, and companies sitting on cash that they could invest with if they saw good reasons to do so.
One final beef with this story. Irwin cites economist Kevin Hassett at the end of the piece suggesting that cutting government benefits to individuals would be more stimulative than cutting government infrastructure. Besides being backwards鈥攖he question is what would hurt growth least, not which 鈥溾�uts would be more beneficial鈥濃�攖he evidence I鈥檝e seen, like Table 11 , shows infrastructure in the middle of the pack in terms of stimulative impact, less than some of the major benefit programs like unemployment insurance or food stamps.
And here鈥檚 something else on infrastructure, from someone who鈥檚 spent part of a career tracking its impact: compared to the other spending programs that get resources to folks who need it and will spend it quickly, it鈥檚 slow. Remember, at the heart of this argument is policy measures that would generate 鈥渋mmediate relief,鈥� something a lot of people in this economy could use right now.
I鈥檓 all for infrastructure investment鈥攊t鈥檚 a key input to our economic productivity, security, and living standards. But compared to spending on individuals, its stimulative impact usually occurs in the medium term, not right away.
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