WHEN EUROPEAN CENTRAL BANK President Jean-Claude Trichet asserted last weekend that the fiscal retrenchment taking place in the European Union ought to boost consumer confidence and thereby spur economic recovery, it sounded awfully familiar to students of economic history.
"Nothing is more important than balancing the budget," asserted President Herbert Hoover in 1931 as he sought a huge tax increase in the midst of the Great Depression. The tax hike would be "indispensable to the restoration of confidence and to the very start of economic recovery," he added.
And while the popular view of Hoover was of hidebound Republican fiscal conservative, he reflected the bipartisan consensus. The Democratic Party platform of 1932 called for the federal budget to be balanced immediately, while then-candidate Franklin D. Roosevelt excoriated the Hoover administration for running budget deficits.
Oblivious to this precedent, the finance ministers of the Group of 20 major industrialized nations last weekend endorsed fiscal retrenchment to deal with the debt crisis that has cut a swath across southern Europe -- even as most of the industrialized world either remains in recession or shows signs of a slowing recovery.
The mood in both parties of Congress has turned decidedly anti-deficit, meaning that the job-creation programs once favored by the White House and Democratic leaders in Congress have been cut back, then cut again. It is a measure of the mood that Mr. Obama on Tuesday hailed an initiative by his administration to cut the budgets of most major government agencies by 5 percent, at a time when conventional theory would call for more government spending to lift the economy.
Even the Federal Reserve is pulling in its horns. No one could expect it to cut interest rates further — they are at rock bottom. But spurred by inflation hawks in their midst, the Fed has gotten out of the business of buying Treasury securities and mortgage bonds, one of its main strategies over the last two years for pushing down long-term interest rates.
Over the last few weeks, the cautious optimism that the economy is on the mend has given way to more caution than optimism.
First, let's review a few basic economic facts.
Here is the GDP equation: C+I+(x-i)+G=GDP. Or, consumer spending plus investment plus (exports net of imports) plus government spending = GDP. Notice that right off the bat we have government spending as part of the equation. In fact, if we look at figures from the CBO we see government spending has traditionally accounted for about 20% of US GDP since 1970 (give or take a few percentage points). In other words, there has not been a government takeover of the economy. In fact, government spending is integral to the economy.
The question now moves to, "is this the right time to cut spending?" Gee, I don't know. So let's look at the data.
As I've point out, things in general are getting better. But there is one indicator that is really not doing well: unemployment. At minimum, unemployment benefits should be extended.
But, let's say the government spends $400 billion on something like ... infrastructure. This would serve two important ends. First, a lot of the unemployed are blue collar, manual labor employees. Infrastructure spending would give them jobs. Secondly, this investment would have a multiplier effect, meaning we would get a lot more out of the investment than we put in. Ever wonder why the economy grew really strongly in the 1960s? A big reason is we started building the highway system in the 1950s, thereby enabling us to move goods more efficiently across the country.
Folks -- this really isn't that complicated. It's really not. The problem is there are politicians involved. The Republicans have embraced an anti-intellectual agenda for so long that they have lost the general ability to reason. The Democrats have absolutely no business sense or leadership ability. Hence, we get the worst of all worlds: one party that is stupid and another that hates business and can't make a decision. Great.