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Jared Bernstein

Jared Bernstein

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Cut and Grow? I Say No

Posted: 05/25/11 01:44 PM ET

Neil Irwin's Washington Post piece this AM provides a useful review of the different ways economists and politicians are thinking about the short-term impact of spending cuts on growth and jobs.

I've been pretty aghast to hear claims that large cuts would immediately generate job growth (and Irwin should have at least quoted someone with that view in the piece) when the opposite is almost surely the case. You can make this a lot more complicated, but when you're as far below capacity as we are -- when so many people are unemployed, e.g. -- it's really quite simple arithmetic. Government spending feeds right into GDP growth and cuts subtract from it.

Now, when you're at full capacity, it's different. At that point you're pouring water into a glass that's already full so you're just wasting water. And you're going to need some paper towels to clean it up (that's inflation in this example -- sorry, it's early and I'm only partially caffeinated).

But with GDP growth just around trend (positive but not all that strong) factories with capacity to spare, and 20+ million un- or underemployed, there's space in the glass. In fact, if you look at the GDP or employment accounts, it's clear that state spending contractions are a real drag on growth and jobs right now. (Maybe I'll try to post some graphs on this later.)

If I ran the country and had my druthers and wasn't constrained by today's budget politics (yes, that's a lot of 'ifs'), I'd do another round state fiscal relief.

The story the "cut-now-and-grow" lobby wants to tell depends not on arithmetic, but on what Krugman calls the confidence fairy (she's good) and the crowding-out troll (he's bad). In a tight budget environment like today's, politicians love the fairy because she provides free stimulus. And since she's a fantasy, you can attribute anything you want to her: "confidence in the markets depends on [your favorite budget cut here]!!"

Then there's the notion that high public spending levels are crowding out private borrowing. Again, not a plausible story with excess capacity, the Fed funds rate at zero, and companies sitting on cash that they could invest with if they saw good reasons to do so.

One final beef with this story. Irwin cites economist Kevin Hassett at the end of the piece suggesting that cutting government benefits to individuals would be more stimulative than cutting government infrastructure. Besides being backwards -- the question is what would hurt growth least, not which "...cuts would be more beneficial" -- the evidence I've seen, like Table 11 here, shows infrastructure in the middle of the pack in terms of stimulative impact, less than some of the major benefit programs like unemployment insurance of food stamps.

And here's something else on infrastructure, from someone who's spent part of a career tracking its impact: compared to the other spending programs that get resources to folks who need it and will spend it quickly, it's slow. Remember, at the heart of this argument is policy measures that would generate "immediate relief," something a lot of people in this economy could use right now.

I'm all for infrastructure investment -- it's a key input to our economic productivity, security, and living standards. But compared to spending on individuals, its stimulative impact usually occurs in the medium term, not right away.

This post originally appeared at Jared Bernstein's On The Economy blog.