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U.S. Faces ‘Real-Time Experiment’ in Economic Recovery While Cutting Spending

May 1, 2013 at 12:00 AM EST
As Europeans protested austerity for May Day, the Federal Reserve said it will continue to stimulate the U.S. economy, but expressed concern that spending cuts are restricting growth. Robert Kuttner of The American Prospect and economist Kevin Hassett join Judy Woodruff to debate the merits of austerity abroad and in the U.S.
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JUDY WOODRUFF: As we mentioned earlier, the Federal Reserve today was critical of current fiscal policy in Washington. In a statement issued after their regular meeting, Fed governors wrote cuts in government spending are — quote — “restraining economic growth.”

We look at the renewed debate surrounding spending and austerity now. Robert Kuttner is a founder and co-editor of The American Prospect magazine. He’s the author of a new book, “Debtors’ Prison: The Politics of Austerity vs. Possibility.” And Kevin Hassett, an economist who has written papers on this subject. He served in Republican administrations and is now the director of economic policy studies at the American Enterprise Institute.

Welcome to you both.

And, Robert Kuttner, to you first. Let’s start with the United States. What are some examples of policy right now in this country that you believe are hurting economic growth?

ROBERT KUTTNER, The American Prospect: Well, we had the New Year’s deal that President Obama made with the Republicans that was supposed to head off the so-called fiscal cliff.

That took about $200 billion dollars out of economy. We raised Social Security taxes two points. We raised taxes on the top one percent, and then to compound the damage, we have the sequester, which was executed in March.

So, those two things together, according to the Congressional Budget Office, which is a bipartisan outfit, cut the growth rate by — in half this year from a projected three percent to a projected 1.5 percent. If you are in a depressed economy and you reduce purchasing power further, you are only going to make the economy more depressed, and far from getting closer to an improvement in debt ratio, you are going to reduce the GDP relative to what it would have been and so the debt ratio is going to get worse.

So, we have had a real-time experiment both in the United States and in Europe in the failure of austerity policies to dig the economies out of the hole they are in.

JUDY WOODRUFF: Kevin Hassett, do you accept his examples as a sign that growth has been cut and this is how?

KEVIN HASSETT, American Enterprise Institute: Sure. Yes.

Absolutely, Robert’s numbers are very precise and accurate. I mean, the 1.5 percent is the CBO estimate. I did my own back of the envelope on the car over, and it was about the same. But the fact is, I think that we need to step back and think about what is going on in Europe and all the unrest and put it in a slightly longer-term perspective to understand where we are and what policy decisions we have to make.

The fact is that before the crisis the government spending to GDP in the typical industrialized country all in counting state and local was about 39 percent. Because of expansionary Keynesian policies, but also built-in stabilizers like having to pay more unemployment insurance for folks and so on, it jumped up to about 44.5 percent.

JUDY WOODRUFF: You are saying there’s a lot of spending going on?

KEVIN HASSETT: Yes. But it’s still way above where it was before the crisis.

So, in the average industrialized country, it’s gone from about 44.5 to 42.5, which is still above where it was before the crisis, and so there have been reductions. They have reduced growth relative to the peak. But at some point, you kind of run out of money if you keep spending — deficit spending up around nine, 10 percent.

And so the governments have had to ratchet back because they had pursued Keynesian policies. And now they’re coming back and we’re in the hangover period.

JUDY WOODRUFF: Now, you are folding Europe into this conversation. I was trying to keep them separate. But maybe that’s not possible.

KEVIN HASSETT: OK. Sure.

JUDY WOODRUFF: Robert Kuttner, what about that, the fact — his point is pretty clear that the spending was just practically out of control before, and, yes, there have been some cutbacks, but not very much?

ROBERT KUTTNER: You know, it really wasn’t out of control.

The biggest single source of the increased deficit was the recession. And let’s not forget what caused the recession. It wasn’t government spending being out of control. It was a financial collapse made on Wall Street. And if you have a financial collapse, the government collects less revenue and spends a little bit more on things like unemployment compensation and food stamps, and so the deficit goes up.

But it doesn’t logically follow that you can get a recovery going by cutting the deficit, because the only thing that is keeping the economy afloat, given the weakness of wages and salaries and private demand and private investment, what is keeping the economy afloat is deficit spending, public spending.

And so the time to get the deficit under control is when the economy is booming. It’s not when the economy is in a ditch. And that’s why these policies don’t work.

JUDY WOODRUFF: What about that? And that is part of what the Federal Reserve said today.

KEVIN HASSETT: Right.

Well, the problem is that a Keynesian policy is well-designed if you can do it right.

JUDY WOODRUFF: And Keynesian plan meaning …

KEVIN HASSETT: Which means spending, trying to drive up government spending in order to drive growth — is perfect if you look at the historic recession that lasted about 11 months and then we grew about 6.5 percent the year after.

If we could take some of the government spending from the 6.5 percent year, move it into the year where we have a recession, then of course it’s a good idea if you can do it. The problem is that we’re in a protracted period of slow growth. And we’re trying to build a kind of Keynesian bridge, a government spending bridge to when we’re growing stronger.

But the evidence — the other Reinhart and Rogoff evidence from a different study is that it usually takes about a decade to recover from a financial crisis. And so spending our way out of that is a really, really hard thing to do. And governments haven’t been able to sustain it and that’s why pretty much across the industrialized world, everybody has been cutting back on spending and increasing taxes to try to get ahead of the curve on deficits.

JUDY WOODRUFF: What about that point? Robert Kuttner, you are shaking your head.

ROBERT KUTTNER: Well, it takes a decade to get out a crisis or it takes a year or two depending on what government does.

What Europe has demonstrated is, if you put the whole economy in a debtor’s prison, it is going to take twice as long, three times as long. The reason I call it a debtor’s prison is that if you put somebody in a debtor’s prison, you ruin their ability to earn a living and they can’t help themselves, they can’t help their creditors.

There’s a terrible double standard in debt. We have done some work on this at Demos, where I’m a senior fellow. A corporation can get out from under debt by declaring Chapter 11. But a student debt carries that student to his or her grave. If the parent co-signs the student loan and the student dies, the parent is still responsible.

We have a trillion dollars of student debt. What a thing, what a gift to give the next generation. Mortgage holders can’t declare Chapter 11, but corporations can. So, there are huge double standards here. And Europe just demonstrates that you can’t deflate your way to recovery.

The way to get the debt ratio down is to get a recovery going. World War II is history’s great example. We went from 12 percent unemployment to zero percent in the course of six months because government spent serious money. And then we grew out way out of that. So, I think the whole view that let’s tighten our belts and the economy will recover is just being refuted day by day.

JUDY WOODRUFF: You not only argue, Kevin Hassett, that belts should be tightened. You argue for much deeper cuts in entitlement programs like Social Security, Medicare in this country and the equivalent programs in Europe.

KEVIN HASSETT: That’s right.

The economist’s language for it is a fiscal consolidation. And there have been many studies of fiscal consolidations that suggest that a country has a better long-term growth prospects if it gets ahead of the curve on debt. But you need to do it in a measured way. You don’t want to front-load all the pain right now.

And I would actually agree with Robert. If you look at European nations, for example, they have had a heck of a lot of contraction, of contractionary fiscal policy. And Robert was good to mention the tax increases here in the U.S. They have had tax increases like that in Europe throughout Europe and spending cuts. And they have front-loaded them. So, they really have cast Europe into a recession with this austerity in some pockets.

But don’t forget the reason they are doing it is that nobody really wanted to lend to Greece because their deficits were so large, their policies were so unsustainable that the country looked like it might go bankrupt.

JUDY WOODRUFF: Let’s end by asking you both what you think needs to be done right now in the United States if you could wave a magic wand and have Congress do it.

Robert Kuttner?

ROBERT KUTTNER: Well, I don’t think you should have the kind of grand bargain that President Obama is talking about with the Republicans, where you cut Social Security, you cut Medicare, and in exchange the Republicans agree to raise taxes and you have 10 more years of austerity.

I think, in the next year or two, until the economy gets back on its feet, you need public spending to put people back to work, rebuild the infrastructure that would make the economy more competitive. And then, when you get back to something close to full employment, people have jobs, people are paying taxes, then you can start reducing the debt because you have a higher growth rate, and the debt starts coming down, the debt ratio, that is, of its own accord. That’s the time to rebalance.

JUDY WOODRUFF: And would that be your remedy?

KEVIN HASSETT: I think the thing that should be the headline for listeners is not necessarily what I want, but what has already happened.

If you look at the CBO’s analysis of what President Obama and the Republicans have already agreed to, then they have stabilized the debt at a pretty reasonable level, about the average of the last 20 years, relatively quickly. And my guess is, given that, there’s going to be a lot of posturing in Washington, but in the end, they are probably not going to do much more either way. There won’t be more tax increases. There won’t be more big spending cuts.

It might be different from what I would want, but I think listeners should know that despite all the rhetoric, they have made a lot of progress already.

JUDY WOODRUFF: Well, the debate — and it is a debate — goes on.

Kevin Hassett, Robert Kuttner, thank you both.

ROBERT KUTTNER: Thank you.

KEVIN HASSETT: Thank you.