Monday, May 7, 2012

Christina Romer on the long-term debt

And then there's my crush (don't tell Kate!), Christina Romer. She has Paul Krugman's consistency, but perhaps with more diplomacy. Plus she's a macroeconomist that always has endogeneity problems at the front of her mind which can be rare, and is something that I've always appreciated about her work.

1. "Once legislation is on the books, politicians, even from opposing parties, have little incentive to change it. Why mess with a consolidation that’s already last year’s — or sometimes the last decade’s — news?...

Markets don’t want counterproductive measures. For credibility, what matters is the nature and the composition of the tax and spending measures, and the clarity of the phase-in schedule…

What about the United States, which faces a terrible long-run budget problem, but no immediate threats from the bond market? The best policy here is to combine the backloaded consolidation I’m recommending for troubled countries with the short-run stimulus I’m advocating for countries like Germany. We could enact something like the Bowles-Simpson plan to reduce the deficit sharply over 10 years, and include in it more near-term investment in infrastructure, education and scientific research.

This would lower unemployment faster, and put us on a path to fiscal health. And, by strengthening our growth, it would help the world economy, too.

These policies are nuanced, so they are easily caricatured as doing something with one hand and undoing it with the other. Their key element is dynamics — using credible plans to lower borrowing costs and address long-run fiscal problems, while not taking immediate austerity measures that would raise unemployment when what countries need most is growth.” (here).

2. "But if federal policy makers do decide to reduce the deficit immediately, reducing spending alone would probably be the most damaging to the recovery. Raising taxes for the wealthy would be least likely to reduce overall demand and raise unemployment.

What about the long-term health of the economy? Here, too, the relative costs of tax increases and spending cuts are often misstated.

Higher tax rates reduce the rewards of work and investing. This can have supply-side effects that lower economic growth over decades.

But a large number of academic studies has found that these effects are relatively small. An excellent survey due to be published in the Journal of Economic Literature found that raising current tax rates by 10 percent would reduce reported income — the end result of work and entrepreneurial effort — by less than 2 percent. That is far less than what was hypothesized by prominent Reagan-era supply-siders like Arthur B. Laffer. He and others postulated that raising taxes 10 percent would ultimately reduce income by more than 10 percent, leading to a decline in tax revenue.

Certain spending cuts may also have small effects on long-run growth. Entitlement spending on Social Security and Medicare could probably be slowed without reducing the nation’s productive ability. But as the bipartisan National Commission on Fiscal Responsibility and Reform emphasized in a report in December, such changes can and should be made in a way that protects the most vulnerable Americans.

Government spending on things like basic scientific research, education and infrastructure, on the other hand, helps increase future productivity. This type of spending often produces high social returns, but the private sector is unlikely to step up if the government pulls back. Case studies described in a recent survey found that less than half of the returns from research-and-development spending were captured by the private investor, so corporations shy away from such endeavors. Cutting federal funds for R&D. would leave a void and could have significant long-run effects on growth.

These long-term considerations, like the short-run concerns, point to a plan for reducing the deficit that combines spending cuts and tax increases. The cuts should spare valuable investment spending. On the tax side, nearly every economist I know agrees that the best way to raise revenue would be limit tax breaks for households and corporations.” (here).

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