In a speech today, Federal Reserve Vice Chair Janet Yellen took policymakers to task for failing to provide support for the economy, noting that spending cuts have been a “headwind for the recovery“:
Discretionary fiscal policy hasn’t been much of a tailwind during this recovery. In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries, as exhibit 3 indicates. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery.
State and local governments were cutting spending and, in some cases, raising taxes for much of this period to deal with revenue shortfalls. At the federal level, policymakers have reduced purchases of goods and services, allowed stimulus-related spending to decline, and have put in place further policy actions to reduce deficits…While a long-term plan is needed to reduce deficits and slow the growth of federal debt, the tax increases and spending cuts that would have occurred last month, absent action by the Congress and the President, likely would have been a headwind strong enough to blow the United States back into recession. Negotiations continue over the extent of spending cuts now due to take effect beginning in March, and I expect that discretionary fiscal policy will continue to be a headwind for the recovery for some time, instead of the tailwind it has been in the past.
Former President Bill Clinton said much the same thing last week, noting that “everybody that’s tried austerity in a time of no growth has wound up cutting revenues even more than they cut spending because you just get into the downward spiral and drag the country back into recession.” The experience of Europe should be showing U.S. policymakers that cutting spending in a weak economy backfires, squashing economic growth, which causes debt to expand. But it doesn’t seem like that lesson is taking hold.