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Government Austerity is the Problem
Posted by Karen Traeger on Aug 13 2012
Blog >>

By:  Bob Lucore

The Gross Domestic Product (GDP) figures, released late last week, show an economy that continues to struggle because there is not enough demand to purchase the output that could potentially be produced.

The economy cannot grow faster than the demand for economic output. If producers cannot sell their goods and services, they quickly learn to cut back rather than pay costs for producing unsold goods.

Demand can come from four broad categories:

• Consumption - what consumers spend to buy goods and services
• Investment - business spending on new facilities, tools, factories and the like—not to be confused with financial investment, which is the mere changing of hands of ownership of financial assets
• Government purchases - including building schools and repairing roads
• Net Exports - the difference between what we buy and sell abroad

The GDP data shows that none of the categories above are expanding enough to raise the economy out of the doldrums. With high unemployment and lagging incomes, consumers are strapped to buy more. We have been exporting far more than we import for some time—and most other countries are also in the doldrums and unlikely to demand more American goods and services. The business sector, especially the larger corporate sector, has lots of accumulated cash, but little incentive to invest it in new facilities or hire new workers. Private business has been growing and hiring, but not fast enough to make up for the declines in the public sector due to government cuts.

Economics, since the Depression, has taught that under such circumstances, it makes sense for the Government to step up spending. However, our policy makers, pundits and media have fallen under the spell of “austerity.” Austerity prescribes steep cuts in government much like medieval healers prescribed bleeding the patient. Government spending cuts now represent a huge drag on the economy. This is especially acute at the state and local level, as Jared Bernstein illustrates this well in this recent post.

Ironically, those who are awash in cash would love to find a safe place to park their money. So, they seek to invest in federal government debt by buying bonds. This has kept interest rates on U.S. Treasuries at record low rates. Some are even negative, when adjusted for inflation. It is essentially free for the federal government to borrow money and spend it, as Paul Krugman has often pointed out.

The sensible federal policy would be to borrow money in the short-term to stimulate the economy. An especially effective way to do this would be for the federal government to borrow and transfer money to cash strapped state and local governments. Once the economy is back on more even footing, it will be easier to pay off the debt—just as the growth from massive debt spending during World War II was easy to pay off during the post-war boom. Furthermore, as James K. Galbraith often says, we are in no danger of ending up like Greece or Spain, because the money we borrow is in dollars, and the supply of dollars is firmly in the hands of the U.S.

However, sensible policy has little chance of succeeding in the current environment. Therefore we need to change the political environment. We can start by keeping the presidency and taking back the House this November. That alone won’t fix the problem, but it will give those advocating sensible economic policies a chance to have their views considered.
 

Bob Lucore, a long-time ADA board member, is the former Director of Research and Policy for the United American Nurses and has worked for the Teamsters and the Department of Economic Research at the AFL-CIO. He taught economics for several years at Centre College and Colorado State University and is currently studying Library and Information Science at San José State University.

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