by NYF Team on August 8, 2011
Garett Jones is BB&T professor for the study of capitalism at the Mercatus Center at George Mason University. In the past, Jones has served as a staff economist to the Joint Economic Committee of the US Congress. As a commentator he has recently featured in the New York Times, the Wall Street Journal, Reuters, CNN.com, Fortune.com, and other media outlets. He answered questions about the implications of the US debt-ceiling crisis over email.
NYF: Could you describe the impact the lengthy debt-ceiling debate has had on the US economy and on world markets?
GJ: The world has concluded that we’re not the grown-ups they thought we were. And that’s not good news.
That doesn’t mean they think we’re likely to default; we’ll probably be officially downgraded to AA (S&P is debating a downgrade as I write), and mentally, the world has probably already made that downgrade. Economists and finance professors will have to change all of our lecture notes: instead of treating US Treasuries as the “risk free asset” in our models, we’ll have to change our notes to read “German bonds” or “Singaporean bonds.”
And it’s not just that investors think the US is likely to play these nasty games of poltical chicken every few years. That’s a problem, yes. But the bigger problem was the failure to embrace the bigger deals that were on the table — the Gang of Six plan, the $4 trillion “almost” plan, anything in the grown-up range.
In the last decade, we’ve botched three chances at fixing our long-run fiscal problems: the Clinton-era surpluses were allowed to evaporate, Social Security reform never happened (in embryonic form, it was designed to make the system more progressive), and now, with fiscal crises erupting across Europe, we passed up a chance for serious fiscal consolidation and entitlement reform.
The US is looking more like a normal country.
NYF: Neither political party seemed happy with the debt-ceiling agreement. But is it fair to say that the Republicans won?
GJ: In the world of political campaigning, yes, obviously: $2 trillion in possible spending cuts, no tax hikes. “We kept taxes from going up”: that’s a GOP campaign consultant’s dream.
But to the GOP policy wonks, this was a loss. The policy people know that they could’ve had a $4 trillion package, with less than $1 trillion of that coming from revenue increases; that’s the deal Speaker Boehner and the President almost sealed.
As Milton Friedman is alleged to have said, “To spend is to tax.” So every foregone spending cut means a future tax increase. That’s why this was a loss to small-government Republicans: a trillion dollars of foregone spending cuts means a government that consumes more of the national pie (a net waste to most Republicans, unless they’re talking about the military) and it means higher taxes in the future (with worse incentives to work and save).
But the modern GOP is all about prevening current tax increases, not future tax increases. As long as the GOP isn’t in charge the day the tax increase occurs, GOP voters won’t blame Republicans. That means we’ll just have to wait for Democrats to get elected so they can raise taxes to pay for all of the spending programs Republicans (and Democrats) voted for.
In short, to serious policy people, the trillion-plus in spending cuts left on the White House negotiating table is a win for the long-run policy goals of Democrats and a loss for the long-run policy goals of Republicans.
NYF: There have been suggestions this week that the US faces a double-dip recession. How likely do you think that is?
GJ: I don’t see the signs pointing to a conventional recession with the typical spike in unemployment, the collapse in investment and inventories. The financial indicators are actually OK — short and medium-term borrowing costs in the the AA and BBB markets are low, and the broad money supply, M2, has finally started growing at a normal rate.
But I do see signs that we’re more of a Japan-style zombie economy than I had thought before. The crippled balance sheets of households, banks, and (to a lesser extent) businesses mean that it’s hard for people to put skin in the game. And since skin in the game — equity — is central to building the trust needed to get big projects done, that means we’ll be thinking small for quite a while.
And if long-term growth is, say, 1% slower than usual, that means you have a bigger chance of getting technical recessions — a sustained period of declining economic activity. But the real issue isn’t the odd, short recession. The real issue is the chronic awfulness that comes from being an economic zombie. And as Rogoff and Reinhart never tire of reminding us, debt, public and private, looks like a root cause cause of the zombification that happens after a financial crisis.
NYF: In your view what does America need to do to emerge from its current financial predicament? And what do you think will actually happen?
GJ: We need to realize that especially after a financial crisis, debt has negative spillover effects, negative externalities. We’re used to thinking of negative externalities as coming from things like pollution or awful fashion trends, but debt — these contractual promises to repay a fixed amount at a certain time — creates its own set of bad spillovers. Partly it’s because of the political externalities: many over-indebted parties get government bailouts that weaken people’s incentives to use resources carefully. The bad political effects of debt — including the Too Big To Fail problem — are pretty well understood. Anil Kashyap and his coauthors have shown that’s part of the reason for Japan’s zombie economy — politically-sensitive industries that got easy credit grew more slowly and innovated less.
But partly it’s because when the economy is weak, my ability to keep a promise depends on getting everyone else to give a little — by paying my workers a little less, by asking a supplier to wait an extra month for her money. It means that even if a bank loans money only to promising projects, every extra loan might make all the other pre-existing loans perform just a little bit worse. That doesn’t mean the loan shouldn’t be made from society’s point of view — it just means we won’t get the social bang for the buck we expected.
If voters and politicans started to see debt as having some bad side-effects — especially after the collapse of an asset bubble — then we might see a lot less support for government-guaranteed lending programs and more support for slightly higher inflation (so we can outgrow our debts). It might also lead to support for some programs I’m less supportive of, but which still might have big payoffs: Ken Rogoff’s plan to get rid of underwater mortgages by creating partial equity partnerships in homes, for example. In his plan, the homeowner and the bank would share both the upside and the downside of a home’s price fluctuation. People can sell their home when they get a good job offer in another town, and they still take care of the home even when the price falls 20%.
Improving the nation’s balance sheet, both in the public and private sectors, is central to fixing our financial predicament, because a healthy balance sheet creates a healthy income statement.
I don’t think it’ll happen any time soon: the political barriers are just too high. Voters and politicians and trillion-dollar banks alike all want the security and the purchasing power that comes from debt, so the most likely outcome is that we muddle along, Japan-style, zombie-style, for years to come.