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Someone asked me on Facebook about what I thought the US debt limit situation, in response to a post by Paul Krugman. My answer was a reasonably comprehensive summary so I thought I’d repost it here:

On the debt limit, he’s right that about its history and that it has no basis in economics. However, because the US has been unable to reign in spending and tax cuts, I personally think its a good political solution to this perpetual addiction to spending.

On slashing spending, the question is mixed as to whether Keynesian economics works during a recession caused by a financial crisis. I agree that during ordinary recessions (when private demand decreases, then government demand should increase to smooth out the ups and downs of the economy).

But during a financial crisis (where there is too much debt in the economy), there is a period of deleveraging when the proportion of debt in the economy decreases. Because debt is a way of magnifying economic growth, removing debt from the economy necessarily slows down the economy. Government spending may drag out that process. For example, Keynesian solutions didn’t work during the Japanese financial crisis of the 1990s, which is now known as the Great Stagnation (that lasted until 2003, and is arguably still happening).

But honestly, I just don’t know.

The other point I’d make is that spending cuts are a good idea in te long run. During the Reagan president, an economist called Matt Laffer argued that cutting taxes will pay for itself by accelerating economic growth so tax revenues increase. That argument is empirically wrong i nthe short run (though, arguably correct in the long run). So, slashing spending and taxes is a good idea in the long run – but it may be damaging to the economy in the short run (as Krugman points out).

On brinksmanship, it taks two people to tango. The Democrats are being overly protective of social security. As I’ve said before, healthcare spending and social security spending must plummet in the US. Krugman has a continual vendetta against the Republicans and I really dislike his language. The Republicans wanted to push the negotiations up fom the VP to the President.

It is sensible to balance the budget in the short run by increasing taxes a little and slashing spending a little (as the Dems argue). But as a way to stop the US’s long term addiction to spending and taxes, it would be better to follow the Republican line. But as a political matter, I don’t see why the Republicans don’t argue something like “We will not agree unless taxes on average stay constant”. Then, they could close the tax exemption for private jets whilst decreasing taxes for, eg, small business. Then the Republicans look like the good guys. I reckon that’s what will end up happening.

 

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