Confidence in Our Fiscal Future

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Tyler Cowen:

The point is not that aggressive fiscal policy is always bad. The point is that there are plenty of coherent models where fiscal consolidation is better than fiscal expansion. “Lack of confidence in a nation’s fiscal future” is a key condition for many of those models to hold. Is that not possibly the case today?

I think his premise that people don’t acknowledge the existence of such coherent models is a little bit odd. After all, one doesn’t need to look abroad or far back in history to find a time when the leading economic policymakers associated with the Democratic Party believed that such a situation existed. The Democratic congressional leadership reached a bargain with President George H.W. Bush in 1990 to cut spending and raise taxes to reduce the deficit. And Bill Clinton and the Democratic congressional leadership reached a deal in 1993 to cut spending and raise taxes to reduce the deficit. And in both cases, I think you could say that “lack of confidence” in America’s “fiscal future” was part of the issue.

But at the time people generally said something more prosaic. They said that interest rates were too high. That was the operational manifestation of lack of confidence. People would only buy U.S. government debt if it paid a lot of interest. That meant that people would only lend to private sector entities in exchange for even more interest. And that was a drag on investment and growth. Fiscal consolidation led to increased confidence, lower interest rates, more investment, and more growth. What would increased confidence accomplish in today’s environment of super-low rates? What’s lacking is not confidence that debts will be repaid (reflected in low interest rates) but confidence that profitable business opportunities will be available even in light of low interest rates.

The point isn’t that there are no times when fiscal consolidation is the correct policy, the point is that we can tell when these times arrive by looking at market conditions.