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P. Gary Wyckoff Headshot

The New Washington Economics

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Let's see if I can get this straight.

The Congressional Budget Office (CBO) is the official scorekeeper for the government's effect on the economy. In calendar year 2013, the CBO projects that automatic spending cuts -- a.k.a. sequestration -- will reduce outlays and the deficit by $44 billion. Because the economy has not yet recovered from the Great Recession, that reduced spending will have a multiplicative effect on GDP. CBO says that the sequester will slow down economic growth by about six tenths of one percent, which amounts to about $97 billion. So for every dollar we reduce the deficit this year, we sacrifice about two dollars and twenty cents in GDP. The cuts will also result in the loss of 750,000 jobs.

So why are we doing this again?

Oh, that's right. Nobody likes the particular cuts in sequestration, but the President and Congress couldn't agree on an alternative. But that's OK, anyway, because everyone in Washington is focused on reducing the deficit. It would be irresponsible to continue to spend more than we take in.

Yep, that sounds reasonable. And the deficit hurts the economy, right?

Yes -- now I remember what everyone said. If we don't reduce the deficit right away, there will be a fiscal crisis and the stock market will melt down. We can't wait until the economy recovers from its slowdown -- we have to act right now.

But wait, that's not it. We've had trillion-dollar deficits for four years now, and the stock market has reached record highs.

OK, then it must be the interest rate effects. Government borrowing pushes up interest rates as government competes with private borrowers. Those higher interest rates will slow the economy down.

Oops, I forgot something. Current interest rates are at historic lows. Since December of 2008, the prime rate has been at 3.25 percent, the lowest rate in five decades.

Well, then the reason must be that countries that have practiced austerity have done better than countries that haven't. Thrift and sacrifice are rewarded, right? We all need to tighten our belts. Families are scrimping and saving, so why shouldn't the government do the same thing?

No, no, that's not right either. The United Kingdom and Spain have embraced austerity, and their economies are mired in an economic quagmire. The UK is experiencing a double-dip recession, exacerbated by the Conservative government's tight fiscal policies. Spain's unemployment rate is a mind-boggling 26 percent.

OK, never mind those effects, then. We can't deny that there is a real cost of the government debt -- the interest we pay on it. We have to give bond-holders a certain return to borrow their money, and that represents a real burden on future generations. The biggest debt-holders are now foreigners like the Japanese and the Chinese, so those interest payments are a real loss to our economy. Just as a family doesn't want to waste their income on credit card debt, the government shouldn't waste its money on interest payments.

Right, that's definitely it. You can't argue with that. I've got it now. So let's see, the interest rate on 10-year government bonds this year is projected to be 2.1 percent. So each dollar of deficit burdens next year's taxpayers with an additional 2 cents in unnecessary costs. So it's definitely worth it, for the sake of future taxpayers, to reduce the deficit, because it reduces debt payments by two cents per dollar of the deficit, even though it reduces the size of the economy in the future by a small amount. OK, I've got my pencil out, the two cent improvement in future well-being is offset by a minor reduction in GDP of -- where are my notes? Oh, here they are. Ohhhh. Two dollars and twenty cents.

I'm confused. According to CBO's numbers, which are widely respected on both sides of the aisle, each dollar of deficit reduction appears to reduce future income by two dollars and eighteen cents. In order to save two cents, we are sacrificing two dollars and twenty cents. This is equivalent to discovering that your car needs a $500 repair bill, so you decide it is more cost effective to buy a new $50,000 car.

I guess I really don't understand the New Washington Economics. I'll keep working on it, though -- there's got to be some logic in there somewhere.