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The US Economy: a solution

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On October 16th President Obama signed into law a bipartisan bill that will open the Government until January 15th, 2014 and raise the debt limit until February 7th, 2014. As well, the bill mandates that the two houses of congress set up a bicameral budget committee to reconcile the differences between the budgets passed by the Senate and House earlier this year. The committee must present a budget by December 13th for votes, and if an agreement can’t be made the two parties will be right back where they started before the Government shutdown.

In recent years, the Republican budget plan has been about spending cuts, and serious ones. The current Ryan budget would cut $4.6 trillion in federal spending, none of which comes out of defense. We’re talking about the EPA, Medicare, Medicaid, Social Security etc. The idea is to cut spending and taxes in order to increase confidence and encourage economic growth, which sounds great, but unfortunately it would only reduce the deficit by $155 billion over the next ten years while turning Medicare into a voucher system, significantly cutting Social Security and significantly hindering economic growth. As the Nobel Prize-winning economist Paul Krugman said, “Republicans eagerly adopted the concept, already popular in Europe, of “expansionary austerity” — the notion that cutting spending would actually boost the economy by increasing confidence. Experience since then has thoroughly refuted this concept: Across the advanced world, big spending cuts have been associated with deeper slumps.”

Krugman refers to European austerity; I don’t see a better representation of this austerity than in Great Britain. Britain’s Conservative Prime Minister David Cameron assumed office in 2010. The year he entered office, he put forth a plan to cut £83 billion ($134 billion), which included 490,000 public sector jobs. He said that the cuts would be, “”fair” and support economic growth.”

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The graph above shows the GDP of Great Britain over the past 5 years. As you can see, the post-recession growth has been quite stagnant. This is what Krugman was alluding to, and is a quite real phenomenon. If you cut spending, and more specifically jobs, while recovering from a recession, then your growth will be hindered.

The great recession of 2008 ravaged the American economy. Our worst quarter was Q4 2009, in which GDP receded by 8.9%. The national unemployment rate doubled from around 5% to about 10% over the course of a year and a half. The Dow Jones Industrial Average had fallen almost 60%, but then something happened. Two major spending bills were passed into law. One called the Troubled Asset Relief Program (TARP), and the other called the American Recovery and Reinvestment Act, but better known as the Stimulus.

 

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TARP was aimed to relieve Wall Street of troubled assets and the Stimulus was a large jobs-and-investment program that tried to jump-start the economy. Now, I acknowledge that there are valid arguments against how these to programs were implemented, but there is no denying that, based on the graph above, the two spending bills had a significant growth-promoting effect on our economy.

I’ve spent most of this article talking about economic growth, and there’s a reason for it. As Harvard Economist Larry Summers wrote, the Congressional Budget Office’s numbers suggest that “an increase of just 0.2 percent in annual growth would entirely eliminate the projected long-term budget gap.” This is profoundly meaningful. This means that even if we took no new policy actions, CBO data would imply that an increase of just 0.2 percent in annual growth would entirely eliminate the projected long-term budget gap, solving our long-tem debt problem.

As I demonstrated with TARP and the Stimulus, an effective way to spur growth is with government spending. Even better, targeted government spending. For example, the setting up of an infrastructure bank to fix our falling bridges, or investment in renewable energy like wind and solar, or maybe something like President Obama’s American Jobs Act of 2011. Whatever the solution, it should be pro-growth and based on empirical data and not ideology. If we elevate our growth, the long-term debt problem will take care of itself.

I will admit that growth is not the only way to tackle our debt problem, but it is the only way to do it and not destroy Social Security and Medicare as we know it. A couple of weeks back, my Grandfather told me that if it weren’t for Medicare he would be dead. These are programs that mean so much to our seniors. We don’t have to compromise them to solve our debt problems, and I hope in the upcoming budget negotiations we will come together and pass a pro-growth budget.

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