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Preemptive Fiscal Adjustment

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"Preemptive Fiscal Adjustment"

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All the hot bloggers and think tanks are working on their long-term deficit reduction plans, but I have to say I’m a bit confused as to why. It’s definitely true that in principle a country should always have a specific plan for returning to long-term balance. But does that ever actually happen? The budget deficit isn’t currently a problem, but it almost certainly will be in the future and that’s when congress will act to deal with it.

I think sometimes that people talk so much about the deficit that they forget that big deficits are often a very real problem. It’s not a subtle thing. You’ll have high interest rates. People will be saying “hey central bank, can you please make interest rates lower.” And the central bankers will say “no, we can’t, inflation’s already at our target level—we won’t make policy looser.” Then politicians will face a choice between tax hikes (unpopular), spending cuts (unpopular), and slower growth (unpopular) and either the incumbents will reduce the deficit or else the opposition will beat them and either need to reduce the deficit or face electoral defeat on their own.

The big deficit reduction deals of the 80s and 90s didn’t just happen for no reason. They happened because the large structural deficits of the Ronald Reagan administration were creating serious economic problems. Today we have serious economic problems, but none of them are caused by the deficit. Inflation is below the Fed’s target. They can keep rates low no problem. It would be wise and just and moral for the 112th Congress to pass a judicious long-term debt reduction program, but it doesn’t seem even remotely realistic. Is there any precedent for a country doing deficit reduction pre-emptively in the way everyone seems to be suggesting we should?

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