The politics of the deficit are utterly backward


The Week has the article The politics of the deficit are utterly backward.

So after that first round of stimulus, the deficit was very large due to all the borrowing. However, its inadequacy was also obvious, as unemployment plateaued at nearly 10 percent — then stayed there for an entire year. During and immediately after the crisis, the centrist establishment was too shocked to respond, but they eventually regrouped and began demanding immediate cuts to balance the budget — effectively aligning themselves with resurgent conservatives, who as usual demanded all social insurance programs be torched.

I’d like to introduce a new concept that is particularly apt for the current situation. An early sentence in the article is the jumping off point for my idea.

A recession means the economy is suffering a shortage of aggregate demand.

It’s not the deficit, but the aggregate demand that is the key. There is a way to boost demand without increasing the deficit. This becomes particularly obvious when one notices the reaction to the FED’s attempt to stimulate.

Like the Great Depression, fiscal stimulus was particularly important during the Great Recession, because by late 2008, the Fed had cut interest rates all the way to zero — pushing its economic accelerator all the way to the floor — and it didn’t halt or even much slow down the recession.

Like a car spinning its wheels while stuck in the snow, pushing on the accelerator just does not help. It needs to get some traction.

The money the FED was pouring into the economy was just going into the hands of the wealthy to speculate in the stock market or to buy US Treasury notes and bonds because there was no place else that made any sense to invest the money. Had the government taxed back all the money that was going nowhere in the hands of the wealthy, and used it to hire people to do work, the recession could have been ended much more quickly with a much smaller deficit.

In fact, even now, the overhang of all that liquidity that the FED pumped into the economy could eventually come back to haunt us should the economy ever really recover. The only way to prevent hyper-inflation might be to drastically raise taxes to suck that money back out of the economy. The proper actions now could be moderate compared to what will be needed if we wait until the emergency becomes obvious.

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