We’re Not Greece, But We Could Be the Next U.K.

From The New Deal 2.0: http://www.newdeal20.org/2011/04/15/were-not-greece-but-we-could-be-the-next-uk-41934/

by Marshall Auerback
Friday, 04/15/2011

We should put the recovery on solid footing by increasing wages and employment, not needlessly slashing government spending.

Just as everybody seems to be understanding the full implications of the UK government’s approach to fiscal policy, we may be on the verge of embracing it here in the US. This a very negative development.

Yes, we should eliminate wasteful and unnecessary spending (we can start with a large proportion of the defense budget). But when we are experiencing a shortage of aggregate demand (the total spending, private and public, that supports employment and output), it makes no sense to introduce further cuts by implementing fiscal austerity, which will simply drain more demand from the economy.

Current proposals from both the President and Paul Ryan for serious deficit reduction involve several trillion dollars of “savings” over the next few years. I put quotes around the word “savings” because the concept is largely predicated on the idea that cutting government expenditure axiomatically creates “savings” when in fact, such “savings” could well induce a greater economic downturn and therefore increase the deficit as a percentage of GDP, as the Irish experience is now demonstrating. The President’s counter to the Ryan proposals will simply set the stage for a bidding war on fiscal austerity.

Ask your favorite economists what that does to GDP. My guess is that they’ll tell you it will shave a few more percentage points off GDP growth. And maybe a 50% increase in unemployment as the output gap skyrockets from already insanely high levels. In other words, we could well see years of flat to negative growth unless the private sector (including non-residents) spending somehow increases at least by that much. AND THE DEFICITS WILL GO HIGHER AS A RESULT!

For household consumption or business investment to fill the current output gap in private sector spending, there would need to be an increase in that sector’s debt (which is likewise measured as a drop in private sector savings). That got us into the mess we’re now in.

Borrowing to spend on houses and cars — the traditional engine of consumer growth — rising to levels sufficient to close the output gap seems highly unlikely and cannibalizes tomorrow’s growth because private debt (as opposed to public government debt) is externally constrained. Particularly when federal deficit reduction is cutting incomes and savings. We want a growth strategy that emphasizes growth in incomes, not credit.

Continue reading at:    http://www.newdeal20.org/2011/04/15/were-not-greece-but-we-could-be-the-next-uk-41934/

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