Marching Backwards: The Consequences of Bipartisan Budget Cutting

Cartoon by Dave Granlund, www.politicalcartoons.com

The rush to fiscal austerity began in earnest by April 2011. A “Keynesian moment” in policymaking had emerged in January 2008 when policymakers debated, constructed, and passed a $150 billion tax-cut stimulus package in a single month, purely based on fears that the unemployment rate might breach 6 percent. But that moment passed quickly. By December 2010, the Obama administration had already acquiesced to an agreement extending the Bush tax cuts for the highest tax brackets (for two years) in exchange for some additional fiscal stimulus.

Just three months later, by the beginning of April 2011, roughly a third of the new fiscal support negotiated in December had been erased by nearly $40 billion in cuts to spending over the remainder of fiscal year 2011. The extended tax cuts for the well-off, needless to say, survived the policy whipsaw that was allegedly driven by the need to reduce the size of the federal budget deficit.

Absent a truly radical break with the current trajectory, the question regarding fiscal austerity for the foreseeable future is simply “how much?” In short, we are about to witness a great experiment—the imposition of fiscal austerity in an economy already characterized by extraordinarily high unemployment. We should think hard about how we developed a politics that led us down this hugely damaging path and what its consequences are likely to be in the next two to three years.

How Keynesianism Came and Went in Three Years

It’s easy enough to explain why fiscal Keynesianism—that is, using increased government debt to finance spending projects, transfers to people and state and local governments, and tax cuts in an effort to fight an economic downturn—came into sudden vogue at the beginning of 2008. Private spending—driven by the collapse of an $8 trillion bubble in home prices—simply collapsed, falling by roughly 8 percent of GDP. This shock to private spending was bigger than the shock that led to the Great Depression. What kept a second Depression from happening was largely the fact that today’s much-larger public sector contains built-in shock absorbers (“automatic stabilizers”) that allow tax collections to fall and safety-net spending to rise as the economy falters.

These automatic stabilizers, however, were clearly not sufficient to stop a terrifying downturn—job losses averaged over seven hundred thousand per month for the worst seven months. Given this, it is not hard to see why policymakers were willing to reach deep into the tool kit and grasp something—large discretionary increases in the budget deficit—that hadn’t been used in quite some time. What’s harder to explain is the abandonment of a Keynesian response to the Great Recession, even as unemployment hovers around 9 percent—what would have been its highest level in a generation before the Great Recession hit, and fully 50 percent higher than the merely threatened rates that mobilized Congress into quick action just a couple of years earlier in 2008.

The Strange Ambivalence About the American Recovery and Reinvestment Act

There was obviously much about the official response to the Great Recession that was politically polarizing. In particular, the bailouts of the auto sector and (much more so) the extraordinary efforts undertaken by the Federal Reserve and the Bush administration to save the largest financial institutions—especially the Troubled Asset Relief Program (TARP)—were highly controversial.

However, the signature economic initiative of the Obama administration—the American Recovery and Reinvestment Act (ARRA)—seems like it should have been much more broadly popular. The ARRA provided roughly $800 billion to finance tax cuts to households and corporations, transfer payments to households (like unemployment insurance benefits and food stamps) as well as to state governments (to spend on education and Medicaid payments), and direct spending for infrastructure investments. The architects of the ARRA probably (reasonably) assumed that the balanced portfolio of its spending (roughly one-third of the first two years’ spending went to tax cuts, transfers, and infrastructure projects, respectively) would make...