For going on three years, the developed world's economic policy has been dominated by the revival of the old idea that vast amounts of public spending could prevent deflation, cure a recession, and ignite a new era of government-led prosperity. It hasn't turned out that way.In this administration, that's a feature, not a bug.
Now the political and fiscal bills are coming due even as the U.S. and European economies are merely muddling along. The Europeans have had enough and want to swear off the sauce, while the Obama Administration wants to keep running a bar tab. So this would seem to be a good time to examine recent policy history and assess the results. . .
The original sin--and it was nearly global--was to revive the Keynesian economic model that had last cracked up in the 1970s, while forgetting the lessons of the long prosperity from 1982 through 2007. The Reagan and Clinton-Gingrich booms were fostered by a policy environment for most of that era of lower taxes, spending restraint and sound money. The spending restraint began to end in the late 1990s, sound money vanished earlier this decade, and now Democrats are promising a series of enormous tax increases.
Notice that we aren't saying that spending restraint alone is a miracle economic cure. The spending cuts now in fashion in Europe are essential, but cuts by themselves won't balance annual deficits reaching 10% of GDP. That requires new revenues from faster growth, and there's a danger that the tax increases now sweeping Europe will dampen growth further.
President Obama's tragic mistake was to blow out the U.S. federal balance sheet on spending that has produced little bang for the buck. The fantastical Keynesian notion (the "multiplier") that $1 of spending produces $1.50 in growth was long ago demolished by Harvard's Robert Barro, among others. That $1 in spending has to come from somewhere, which means in taxes or borrowing from productive parts of the private economy. Given that so much of the U.S. stimulus went for transfer payments such as Medicaid and unemployment insurance, the "multiplier" has almost certainly been negative. . .
What the world has now reached instead is a Keynesian dead end. We are told to let Congress continue to spend and borrow until the precise moment when Mr. Summers and Mark Zandi and the other architects of our current policy say it is time to raise taxes to reduce the huge deficits and debt that their spending has produced. Meanwhile, individuals and businesses are supposed to be unaffected by the prospect of future tax increases, higher interest rates, and more government control over nearly every area of the economy.
Wednesday, June 30, 2010
From a June 26th Wall Street Journal editorial: