They almost surely have it wrong. Uncertainty about fiscal and monetary policy was also rampant in the early 1980s: Taxes were cut and raised repeatedly and the Fed tried, then abandoned, efforts to target growth in the money supply instead of interest rates. Yet after a sharp recession in 1981-82, the economy took off, primarily because the recession had been induced by high interest rates and, once rates fell, demand sprang back.
American businesses — with some justification — complain that regulatory uncertainty has increased under the Obama administration. But weak U.S. growth primarily reflects the difficulty of stimulating demand through lower interest rates at a time when the private sector and the financial system are trying to shed debt — exactly the sort of liquidity trap Keynes identified in the 1930s. Other countries have experienced similar stagnation in the wake of financial crises. As for austerity boosting growth, the International Monetary Fund has found that far more often it does the opposite: Cutting the deficit by 1 percent of gross domestic product raises unemployment by 0.3 percentage points. The effects tended to be worse when they were not offset with lower interest or exchange rates.
What would the Republican Party’s new economic ideology mean if the GOP nominee assumes the presidency in 2013? A Republican president would influence fiscal and monetary policy (remember, Bernanke’s term at the Fed ends in 2014 and the president will appoint his successor). The answer is not simple, because the candidates’ views are not monolithic. Bachmann and Paul are at one extreme; former Massachusetts governor Mitt Romney is at the other, personifying Republicans’ more traditional deference to economic orthodoxy and the Fed. In between are people such as Ryan, a rumored but undeclared candidate, who is fine with garden-variety monetary policy but opposes quantitative easing and disparages fiscal stimulus as “sugar-high” economics.
If we take their views at face value, we would not expect the new president, even if dealing with a renewed economic slump, to bless more fiscal or monetary stimulus. Indeed, more spending cuts and higher interest rates could be in store. That would be tolerable if a recovery were well entrenched by 2013 — but would constitute a major headwind if growth remained tepid. A shift toward fiscal and monetary austerity in the United States in 1937 helped prolong the depression. Fiscal tightening helped push Japan back into recession in 1997.
Of course, it’s one thing for a Republican candidate to inveigh against macroeconomic fine-tuning while stumping for tea party votes during the primaries. Once in office, presidents must think more carefully about the consequences of their decisions, both for the economy and reelection. At present, the public is far more worried about jobs than the deficit. Perry has criticized Obama for spending that would make “Keynes blush,” but as governor accepted Texas’s share of the money. Should he end up in the White House, policies that once looked treasonous might start to seem sensible.
Greg Ip is the U.S. economics editor of the Economist and the author of “The Little Book of Economics: How the Economy Works in the Real World.”
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