In case you haven't noticed, the biggest debate in the history of economics is occurring right before our eyes. The question is whether we should keep spending billions of dollars in stimulus to spur demand, business spending and investment or whether we should cut government spending to reduce the deficit, which now stands at 1.4 Trillion Dollars.
Background
The stakes couldn't be higher. Over 35% of people between the ages of 18 and 29 are without work. The unemployment rate overall is 9.5%, but this doesn't include so-called discouraged workers. If you include all discouraged workers, the real number is 21%, approaching great depression numbers. The volatility in stocks is a sign of further danger. Credit is still frozen, and state governments are facing serious revenue shortfalls. I will discuss some of the root causes of this situation in later posts.
Keynesian Economics
John Maynard Keynes was an economist (actually he was a mathematician but is remembered as an economist) who proposed that increasing government spending during a recession would spur domestic demand, in turn increasing business revenue, in turn increasing hiring. FDR accepted this theory and the increased government spending heading into WWII, which got us out of the depression, backs up the theory.
In 2009, congress passed $600B in stimulus spending. Now, the recovery is stalling due to several factors that I will discuss in other posts, and the administration is pushing for new stimulus. However, despite increasingly dire economic indicators, the political trend is against further stimulus spending.
The other side of the story
The federal budget deficit has risen to unsustainable levels. People fear that we will be "the next Greece." In case you didn't know, Greece's debt was downgraded several times in the Spring, prompting fears of sovereign debt defaults in Southern Europe and a potential collapse of the Euro system.
The primary argument on this side is that businesses are hoarding cash and not hiring, and consumers are afraid to spend, because everyone is afraid of US debt default at some future date. Some also argue that increasing government debt diverts private investment away from businesses and into government bonds.
Conclusion
The idea that people cut back spending due to government debt has no basis. People cut back spending due to their own debt, not government debt. Companies hoard cash and decline to hire because there is depressed demand. Continued stimulus, if correctly targeted, should spur demand and get businesses expanding again. If people are not spending due to fear of government debt, then it is irrational fear which is depressing demand. As FDR once said, "the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance."
To me it boils down to a simple proposition: For there to be a run on US Treasuries, there has to be an alternative. Where would that money go?
ReplyDeleteThe US doesn't have the best finances in the world, however, who else would you pick to park your money. Rates are at an all time low and probably will stay there for the time being.