“There’s another myth I need to address,” House Speaker John A. Boehner (R-Ohio) said in a speech this month, “and that is the myth that addressing our debt challenges requires ‘pain.’ ”
This debate — over the impact of immediate budget cuts on a fragile economy — is at the core of a showdown over how and when to trim the deficit. It puts Republicans, who control the House, at odds with the White House and Democrats, who control the Senate.
Both sides agree that over the long term, yawning budget deficits put the country in danger, especially if investors fear that the federal government won’t be able to pay its debts and demand sharply higher interest rates in return for continuing to lend Washington money.
But Republicans, in warning that federal deficits also pose an immediate hazard, are mustering two other arguments. The first turns on the question of business confidence, positing that companies are afraid they will pay the cost of the rapidly rising national debt through higher taxes. This fear makes them reluctant to hire and invest. So cutting government spending will make firms again confident enough to invest and expand, the argument goes.
A second argument, which Republican politicians have embraced but many conservative economists shy away from, is that borrowing by the government is crowding out investment by firms.
In effect, conservatives are now rejecting “root-canal economics,” which many embraced in the 1970s and ’80s. At the time, they argued that some immediate pain was necessary for a stronger growth in the long run.
Today, conservative economists still acknowledge that lowering spending would reduce some economic activity. But they argue that budget cuts, by enhancing business confidence, would partly, if not fully, offset that drag.
“Business spending is a long-run decision that requires an environment that will be beneficial going forward,” said Douglas Holtz-Eakin, president of the American Action Forum and an economic adviser to John McCain’s 2008 presidential campaign. “You have the administration signaling they’re going to solve our fiscal problems by taxing those who do that kind of investment. But if instead you signal your seriousness by doing it through spending cuts and doing it now, the business environment will be better.”
The theory has backing in research by Alberto Alesina, a Harvard economist, examining the economic performance of countries that have reduced previously high budget deficits. Alesina makes relatively cautious claims about what his data prove and the implications for U.S. policy. He acknowledges, for example, that the historical data he has analyzed offer only an indication, not a definitive prediction, of how sharp budget cuts would affect the U.S. economy.
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