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Failure of the Super Committee Might Be the US's Best Hope for Economic Recovery

"Drawing blood” from the economy by cutting government expenditures at a time of high unemployment and underused resources will only ensure the patient’s death, not recovery.

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The outlook for 2012 then depends very much on fiscal policy. Right now according to the Congressional Budge Office (CBO), we are programmed for fiscal restriction of perhaps 2.5% of GDP or more in 2012. That could overcome the natural tendency of economies to grow, especially with real interest rates at negative levels. The question then arises, will we really go through an election year with so much fiscal restriction? The answer, of course, is in the hands of the politicians. As it now stands, the President wants a $447 billion dollar jobs plan. That is equal to almost 3% of GDP. He wants most of it to be financed with borrowings in 2012, with offsetting tax increases in future years. Passage of all of this jobs plan would turn programmed fiscal restriction into marginal fiscal stimulus.

The Republican position has been that, even if they go along with parts of this job stimulus plan like an extension of the payroll tax cut, they demand offsetting greater expenditure cuts. In other words, even if they concede to some of Obama’s demands, they insist on maintaining the overall fiscal restriction that is now programmed because they say that demonstrating a commitment to “budget discipline” will enhance business confidence and allow the private sector to create more jobs.

So let’s assume that the GOP is right: imagine a new government being elected on the promise of cutting national debt and in its first budget outlines a very clear plan to seriously cut the national budget deficit, reduce taxes (but definitely not put them up), cut public employment and free up the regulative environment. And let's say that such a government also pronounced its “pro-business” credentials (self-styled).

In that situation, if the Republican view was correct, we would expect to observe within a few months (certainly within a year) of the new government a reduction in private uncertainty, which, if the concept has any operational application, should influence discretionary behavior such as spending and employment.

It would be reasonable to expect business confidence to rise, which should mean that private investment would accelerate as business owners anticipate a consumer revival. It would be reasonable to expect firms to be keen to get staff in place to meet the renewed expectations of increased orders. It would be reasonable to expect consumers to become more confident and this confidence to translate into their consumption expenditure.

So... how does one explain the UK, which continues to deteriorate in spite of making very clear its plans and implementation for budget cutting? And how does one explain Australia, which has also been working toward reducing government spending, even as its unemployment rate has begun to tip up again?

The economics of the super committee, indeed that of virtually all of the mainstream Washington policy establishment, is still predicated on the economic equivalent of Medieval blood-letting. Continuing to “draw blood” from the US economy via ongoing cuts in government expenditure at a time of high unemployment and underused resources will ensure the patient’s death, not recovery.

 

Auerback is a market analyst and commentator.

 
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