Concentrating The Mind
The Economist reports that the administration’s deficit strategy as expressed in yesterday’s profile of Tim Geithner is correct. At a forum yesterday, they asked the question and got a big affirmative:
The comments from Gene Sperling, Director of the National Economic Council and a key member of the team negotiating an agreement on an increase in the debt ceiling, were clearer still. The White House believes, he said, that deficit-cutting is an important component (the emphasis was his) of a growth strategy. And he repeatedly said that deficit-reduction was crucial in generating economic confidence. Confidence—he repeated this word many times.
He made clear that the administration isn’t being entirely incautious about the risk of fiscal drag on recovery. He pointed out that the White House wanted a 12-year, rather than a 10-year, window for $4 trillion in cuts, so as to reduce their-short term economic burden. He also noted that the administration has fought hard to preserve crucial investment components of domestic discretionary spending, which has been a primary target of Republican congressmen. At the same time, he said it is plain that a deal with the Republicans will involve a “bipartisan downpayment”. There will be short-term cuts, despite warnings from Ben Bernanke, Christina Romer, and many others.
I struggle to understand the logic. Britain counted on “confidence” to lift the economy amid austerity and has been sorely disappointed, despite an accommodative central bank. The literature on expansionary austerity suggests that it’s not an impossibility, but that it nearly always occurs in countries where high debt levels have produced high interest rates. America simply can’t benefit from the interest rate impact of austerity; its interest rates have nowhere to go but up.
No need to struggle if you look at this in the context of the current debt ceiling fight. Having backed themselves into Time Geithner’s fiscal corner, they now believe their only choice is to try to live through the threatened GOP mayhem without causing a full-blown global crisis.
This shift was acknowledged in a note this morning from Citi’s Steven Englander:A breach of the credit ceiling is priced in neither fixed income nor FX markets to any significant degree now. Even two months ago there was a virtual consensus that a debt ceiling breach would be an unmitigated disaster for US asset markets. Confidence in Treasuries as the ultimate safe haven would be destroyed and there would very likely be spillovers into other asset markets. If investors or business were counting on using coupons or redemptions to meet obligations, there would also be the possibility of a series of business or investors defaults tied to delayed Treasury payments.The revisionist view is that a breach of the debt ceiling would magnificently concentrate the minds of Congress and the Administration to reach a speedy deal on longer-term fiscal consolidation. In this view, if brinksmanship or even a few days delay in receiving a payment were the cost of long-term reform, it would be worth it. Longer-term attractiveness of Treasuries might even be enhanced if the deficit were put on a sustainable course.What was previously way out of left field has come closer to the mainstream — a big problem for Tim Geithner, who has called a default “unthinkable“.
Let’s just say that the kabuki has reached a new level. Despite the fears that the Teabag caucus will refuse out of misguided principle, I think we all know that the GOP has “ways” of keeping their people in line when it’s necessary, even if the usual inducements don’t work. But I’m fairly sure that the one thing that everyone now knows will guarantee that this won’t happen is a gigantic capitulation by the Democrats, aren’t you? Wouldn’t that give the markets just as much “confidence” as if the minds had been “concentrated” by a default? I think so.That’s what Gene Sperling really meant when he said this:
And he repeatedly said that deficit-reduction was crucial in generating economic confidence. Confidence—he repeated this word many times.
It seems a sure thing that fiscal policy will be a net drag on the economy in coming quarters, and not an insignificant one either.