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Eurozone’s Possible ‘Lehman Moment’: What it Means for U.S.

As the U.S. election season heats up amid rising debt, Europe's woes, expiring Bush-era tax cuts and a scheduled round of spending cuts, the Congressional Budget Office warned the economy could head back into recession. Judy Woodruff speaks with Harvard University's Ken Rogoff and Josh Bivens of the Economic Policy Institute.

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    And we pick up on Europe's economic crisis to look at the risks it poses here in the U.S., at a time when this country faces its own huge fiscal problem.

    How to bring down the United States' rising debt is a topic of growing debate as we head to an election at the end of this year. That's when the Bush era tax cuts are scheduled to expire and a scheduled round of spending cuts are set to take effect.

    Well, this week, the Congressional Budget Office warned that if all this was allowed to take place, the economy would be knocked back into recession for the first half of next year.

    More on this now from two men who watch the U.S. economy closely, Ken Rogoff of Harvard university and Josh Bivens of the Economic Policy Institute.

    Welcome to both of you.

    And, Ken Rogoff, to you first.

    What is the European scenario that the United States should be most worried about?

  • KENNETH ROGOFF, Harvard University:

    Oh, goodness.

    I mean, there's really a cliff there. There's a possibility the whole euro can dissolve if they don't take a quantum leap towards unification, and we could have a Lehman moment again. It's not hyperbole to say that.

    They have seen that in Europe. They really don't want that to happen again. And yet they can't agree among themselves what are they going to do when Greece leaves, which is the equivalent really of Lehman going under in the United States.


    And, Josh Bivens, even short of the worst-case scenario, the U.S. is already feeling the effects of what's happening in Europe.

  • JOSH BIVENS, Economic Policy Institute:

    I think that's right.

    I think slow growth in Europe and now it looks like outright contraction in a lot of Europe is meaning that we export less. It's a big export market for U.S. goods. And so I would say over the last year, over the coming year, if they enter recession, we're probably talking about less than half a percentage point of GDP knocked off our growth rate because of European troubles, but given that that growth rate is really slow already, that those are precious little percentage points that we can't afford to give up. So, I think we have already felt some effects.


    So, Ken Rogoff, meantime, the Congressional Budget Office, as we were just reporting, is this week saying the U.S. on the edge of a fiscal cliff. Just how bad is the debt problem in the United States?


    Well, the two things weighing on businesses and why they're not investing as much as they should and why they're not hiring as much as they should are Europe and the fiscal cliff.

    They don't know what direction the U.S. economy is going. There is potentially a huge contraction in the U.S. with, as you said, the Bush era tax cuts expiring, payroll tax cuts expiring, and some other changes that would put us into recession. I don't think that's going to happen, but what has everybody nervous is, what are they going to do? Are we going to have tax hikes? Are we going to have government spending cuts? There seems to be no direction, no agreement in Washington on what direction to go.

    And there's this huge cloud of uncertainty here compounding what we're seeing in Europe.


    But what does that — just staying with you, Ken Rogoff, what does that mean for the U.S. considering, as you're pointing out, the U.S. — the economic recovery still very weak? What are the real options for policy-makers?


    Well, we could dream that they would do something like the Simpson-Bowles proposal, where they're going to get rid of a lot of tax expenditures and be able to keep rates low, make reforms to Social Security.

    We have many things we can do so that we can grow our way out of this deep recession that we have been in, so that we can get on a good, stronger growth path in the future. But there's paralysis in Washington — I just don't think it's hyperbole to say that — with two very different, competing visions of where things should go and businesses and the consumer stuck in the middle.


    Josh Bivens, it is two very different visions of what should happen. But just to back up for a minute, how do you see the depth of the debt crisis or debt problem facing the United States?


    Well, I think we should be clear.

    When people talk about the fiscal cliff coming in 2013, it's not a crisis of too much debt. That's a crisis of ramping down debt too quickly. And I think people need to really realize that. The problem with the tax cuts expire, if the unemployment insurance extensions expire, it's all of a sudden spending power will be sucked out of the economy, spending power that's been supported by expansions of debt.

    And in the short term, that's a very good thing and I think it's a real cautionary tale that, yes, we can be concerned about debt projections for 20, 30, 40 years from now, but we shouldn't let that blind us to the fact that the right thing to do here and now is to spend more money, financed by debt, in order to bring the unemployment rate down quickly. And I think that's the real thing we should be focused on.


    Ken Rogoff, how do you see about this question of the danger of drawing — of pushing that debt down too fast?


    Well, I agree with Josh that we don't want to push it down too fast, but I don't agree that we're talking about 30 to 40 years.

    Our debt level is very high by historical standards. It's likely to weigh on growth in the United States for decades, that our debt is so high already. You don't just want to wildly have it go up. But, yes, we are still in a recession. Unemployment is high. We can't really afford to unwind this quickly.

    But I think the key to doing this well is to try to have some real reform, some vision in Washington, when we can both get our debt on a better trajectory and not try to do things too quickly in terms of trying to balance the budget right now.


    Josh Bivens, without — we could get into a lot of detail here, but help us understand why you see the debt situation differently, a little differently from how Ken Rogoff sees it?


    I think there's a couple reasons.

    One is, you know, I just weigh the short-term unemployment crisis really heavily. And, in fact, I'm calling it short-term. That's misleading. It might become — it's already been three or four years of an unemployment crisis and it might linger for a decade to come, if it's not addressed.

    So there is a time when we should worry about deficits being too large. And that time is when the economy is healthy and running at full employment again, because deficits run when the economy is depressed just don't hurt you.

    And I will just say one other thing, too. We're often told that the optimal policy is stimulus now, long-run deficit reduction and discipline later. And that's right. And we really did that over the past couple years.

    I mean, we passed the Recovery Act in 2009. And we passed health care reform, which is a mammoth deficit reducer in the long run. And yet somehow people don't want to give any credit for that. In fact, the CBO in their alternative fiscal scenario basically says, we're not even going to assume that that actually holds in the long run.

    So it's an easy thing to say, short-term stimulus, long-term deficit reduction. It's very hard to actually make it stick. And we shouldn't make that the enemy of fighting unemployment in the here and now.


    Ken Rogoff, what about that point?


    Well, I just don't agree that the deficits aren't a problem now. I agree not to bring them down too fast, that's for sure.

    But to think there's not a long-run secular problem here, given how high our debt is, given where things are going, we could be looking at having a level of income 25 percent lower than it would be otherwise a couple decades from now. This isn't just a couple percent. This isn't like we push the problem out into the future.

    It's a big problem. But that said, obviously, we're running a really big deficit now. Things are still very difficult. We can't move quickly on this. It would be too painful. But I certainly wouldn't say to go in the other direction. Don't jump off the fiscal cliff, but on the other hand, we could potentially have a much bigger cliff coming down the road if we don't start doing really something sooner, rather than later.


    And, Ken Rogoff, you also have worries about this continuing debt and what it means for raising borrowing costs down the road.


    Yes, perhaps raising borrowing costs eventually, if people panic. A country like the United States, people have a lot of confidence that we will do something, we won't go the way of Greece.

    But if you look over history, there are many, many advanced nations that have gotten in this situation. They raise taxes, they don't default, they don't do something crazy, but it slows growth. So you're comparing an urgent problem, indeed, but with a long-term secular problem. And you have to try to balance these things.

    I actually think we have a reasonable balance at the moment if we don't jump off the fiscal cliff, but we don't have a very sensible tax system. We don't have a good growth strategy. We're missing a lot of things. I would concentrate on that. I don't think it's just a matter of there's too much austerity. We're running an 8 percent deficit right now.


    Josh Bivens, what's your take on that?


    A couple things.

    One, it's true we have so far largely resisted austerity at the federal level in the United States. And that's paid off for us. You compare us to, say, the U.K., an economy that had a very similar recession, a very similar recovery until the middle of 2010, when they embraced austerity, when they elected a conservative government.

    Since then, they have stagnated, entered recession. We have continued to grow. I would say at the state and local level, we have not resisted austerity at all. In fact, it's been a big sap on growth, and I think that's been a drag that we should be cognizant of.

    And then again, I think we have largely done — if you think the health reform as enacted actually will be followed to the letter of the law, we have done mammoth deficit reduction in the long run over the past couple years that people just don't want to believe.

    We should do lots of other stuff, too. I would love a simpler and better tax code that was fairer and collected more revenue. We should attack health care costs that are growing too fast and blowing up the budget. But I think here and now, the real problem is unemployment and getting it down quickly.


    Well, all of this, we are going to continue to watch.

    Thank you both, Josh Bivens, Ken Rogoff.


    Thank you.


    Thank you.

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