It is taken as a given that the annual fiscal policy dramas of the past few years (last year it was the “fiscal cliff,” the year before it was running up against the statutory debt ceiling, and this year it’s debt ceiling again plus the need to pass a “continuing resolution” to fund the federal government over the next year) are “bad for the economy.”
The general idea that these fiscal policy fights have hurt the economy’s recovery from the Great Recession is clearly right. However, far too many people get the story wrong about how these annual fiscal dramas have slowed recovery. In short, it’s not that they introduce damaging “uncertainty.” Rather, it’s that they have led to smaller budget deficits, which have sucked purchasing power out of an economy that remains severely demand-constrained.
This may sound doubly strange—the corrosive impact of “uncertainty” is now essentially an official talking point for the Beltway pundit class, and the most treasured cliché of economic commentary is that reducing the budget deficit is nearly always and everywhere a good thing.
In respect to the damage done by “uncertainty,” it’s really hard to convincingly argue that uncertainty can be measured particularly well or (even more importantly) that it’s an independent cause of slower growth rather than a symptom of slow growth. I tried to convince myself that there might be something here a year ago, but in the end it was awfully hard to say anything more than “Does fighting about the statutory debt ceiling in and of itself damage the economy [by introducing uncertainty to economic decision-making]? Maybe.”
One of the biggest problems with the “uncertainty” argument is that both household spending and business investment in equipment and software are actually doing quite well during this recovery, given the enormous wealth loss inflicted by the bursting housing bubble. Personal savings rates are approaching pre-recession lows, and business equipment investment is actually outperforming historical averages.
If household saving and business equipment investment are both doing pretty well, what then is the big drag on growth in recent years? This brings us to our second point—the damage done by excessive deficit-cutting in recent years. The figure below shows growth in inflation-adjusted public spending (federal, state and local) during recessions and recoveries. While the Recovery Act essentially kept this spending strong even in the face of historic hemorrhaging of state and local spending during the Great Recession, since the beginning of 2011, public spending has lagged further and further behind historic averages. In fact, if the average trajectory of public spending following recessions and recoveries of the early 1980s, 1990s, and 2000s were replicated during the latest downturn and recovery, public spending would be roughly 14-15 percent higher today and there would be more than 5 million more jobs (and most of these would be private-sector jobs) in the American economy.
This brings us to our punchline: It’s austerity that is reliably damaging to recover efforts, not uncertainty. And each year’s fiscal drama has tended to produce another dose of austerity. The very large reduction in the budget deficit between 2009 and 2012, combined with the extraordinarily slow pace of recovery over this same time period is not a coincidence. This should be a lesson to evidence-based policymakers: You should be much more worried about accepting more austerity as the price of ending the fiscal drama than any damage caused by the drama itself.