The Best Case I Can Make for Fiscal Retrenchment

(cc photo by Jeff Kubina)

(cc photo by Jeff Kubina)

Following in the footsteps of Brad DeLong and in the spirit of generosity, it’s perhaps worth trying to reconstruct the best argument against stimulus and in favor of fiscal retrenchment that I can make. The story I would tell is that we’re seeing a bit of an ironic switcheroo in which the liberals who normally tell me markets aren’t perfect are now telling me not to worry about the US (or German or Japanese) fiscal deficit because interest rates are so low.

In theory, this is because these securities are “safe.” Investors are confident that these securities will be repaid, and that they’ll be repaid via a mechanism that doesn’t involve massive inflation. But what mechanism? Is it actually true that the United States has a credible plan to close its long-term fiscal deficit? Well, no it’s not. Nor is it true that the U.S. political system seems to be highly functional and capable of making the tough choices need to formulate such a plan. So why are rates really so low? It’s a bubble. Investors view US government debt as “safe” because they’re confident other investors will view it as safe. The social practices of financial markets require something to be the “safe” asset and by convention that asset is US government debt. Investors know that other investors know that yet other investors will view it as safe. Ergo it’s safe, in much the way that house prices always go up. Which is to say that it’s safe until the bubble pops and the animal spirits become seized with panic and everything goes to shit.

In other words, we need to ignore the price signals and the markets and substitute instead the judgment of expert economic planners that there’s too much debt out there.

I think William Galston comes closest to outlining this view and I think there’s something to it. But even if it’s right, the upshot isn’t that we need to act now to cut the deficit now. It’s that we can’t afford to wait until later to cut the long-term deficit. It’s an argument for acting right away on a bill that schedules for the future higher taxes on the rich, higher taxes on greenhouse gas emissions, less spending on defense, and progressive cost-sharing for Medicare.