Repeating a now familiar warning, CBO Direcor Doug Elmendorf told the Super Congress today that too-deep spending cuts could slow even further an already ailing economy, and that short-term higher deficits could be necessary for economic recovery.
Elmendorf’s message: to avoid slowing the economy even further, the deficit must get worse before it gets better.
“If policymakers wanted to achieve both a short-term economic boost and medium- and long-term fiscal sustainability,” Elmendorf said, the “most effective” policy would be “changes in taxes and spending that would widen the deficit now but narrow it later in the decade.”
He warned, however, that the approach would work best if future policy changes “were sufficiently specific and widely supported” so that individuals and businesses can believe “that the future fiscal restraint would truly take effect.”
Elemendorf also discussed the recent findings by IMF economists (and others) that "in countries that really set out to do fiscal austerity, the results tend to not be good in the short term."
"I think the principle lesson of looking at countries like Greece and others is that it is a terrible situation to end up in, where one has to make drastic abrupt changes in policy. But if you look at Greece or Ireland or the experience in the UK which did not face such a crisis but has made a very, very determined pivot in its policy, those economies are not doing very well right now. And I think leaders of those countries felt they had no alternative given where they had gotten to... That they were at a point where people were not lending the governments money anymore or about to stop lending them money.... So they had to make drastic changes. But that is not a situation that we would like to find ourselves in."[...]
It's not just Elmendorf. According to IMF economists, the GOP approach of slashing spending by even just 1 percent of GDP would under current conditions lead to a big spike in unemployment and a sizable drop in incomes, all while doing almost nothing to actually reduce deficits. The effects, according to the IMF are exacerbated when central banks can't reduce interest rates anymore -- a situation the Fed finds itself in right now.
Here that is in graph form from Kevin Drum.
Republicans want all belt-tightening and no spending and no tax reforms or increases. Democrats have fallen into the deficit trap and seem to be fully on the austerity bandwagon. But they, and President Obama who will deliver his "cut it more!" proposal next week, need to take Elmendorf's warning very seriously. The belt is as tight as it needs to get right now.