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Nobel prize winning economist
Free Markets and the Sinking of the Global Economy
Obama Must Resist Deficit Fetish
by Joseph Stiglitz -- 02/10/2010
The economy seems caught between a rock and a hard place: ever mounting
deficits and ever mounting job losses - leading to a soaring jobs deficit.
The economy should have created some 3 million jobs for new entrants into
the labor force over the past two years, instead it has lost roughly 8.5
million. If spending is cut back, to tame the deficit, this jobs problem
could only get worse. If spending is not cut back, long-term interest rates
may rise as inflationary expectations grow. And the jobs problem may still
These problems were not created by President Obama. They are the result of
years of economic mismanagement under President George W. Bush, and
misguided deregulation under Bush and his predecessors. But now, Obama must
deal with them. It will be difficult for him to deal with long-term pressing
problems - like reforming health care or addressing climate change - until
or unless the economy is restored to health. It is little solace that
others, like George Papandreou in Greece, inherited worse problems, and face
less pleasant choices.
There are two basic principles to resolving this dilemma. The first is:
Don't give into deficit fetishism. Financial markets demonstrated their lack
of competence in making economic judgments with their reckless behavior over
the past decade or more. The public has repeatedly had to bail them out from
bad lending decisions. The rating agencies, too, repeatedly demonstrated
their incompetence in evaluating risks. The real risk for America right now
is a prolonged weak economy - something that a mindless focus on deficits
can help ensure.
The deficit hawks from the banking system went on vacation from the fall of
2008 through the spring of 2009, while they demanded money be doled out
freely - to themselves. But now that the public clearly won't stand for
another free lunch at its expense, the deficit hawks are back at work, more
vocal than ever about the need to cut government spending.
They say it was necessary to the health of the economy to dole out money to
the banks; but not necessary to the health of our society to make sure
everyone has access to health care. It was not acceptable to alter the
contracts of the AIG personnel, even those "key" and irreplaceable personnel
who made the mistakes that led to a $180 billion bailout, but acceptable to
break the social contract between America's elderly and the rest of society,
by cutting back on Social Security.
The bankers were short sighted when getting the country into the mess. But
deficit fetishism is equally short-sighted.
It was a mistake to give in to bankers' pleas for deregulation before the
crisis; a mistake to give into their demand for a bailout without
constraints and without appropriate compensation for the government during
the crisis; and even more wrong now to give into demands for unfettered
deficit reductions, including an end to the stimulus. It is simply wrong to
look at only one side of a country's balance sheet. The deficit measures the
increase in liabilities. The relevant question should be: What is happening
on the asset side?
Consider a million dollars of deficit spending. The United States, Britain
and the rest of Europe will be operating well below their potential not only
this year, but for several years to come. With a long-run multiplier of 2
(that is, every dollar of government spending gives rise to a $2 cumulative
increase in GDP), and a federal tax harvest of 20 percent, the net increase
in the federal deficit is only $600,000. The long-run real interest rate is
around 2 percent. So as long as the money is spent on investments yielding a
return in excess of 6 percent, the spending pays for itself. A conventional
societal economic cost benefit analysis (taking account not just impacts on
the budget, but broader economic gains) yields an even lower break-even
point -- 1.2 percent.
JOSEPH STIGLITZ became a full professor at Yale in 1970 at the age of 27,
and in 1979 was awarded the John Bates Clark Award, as the economist under
40 who had made the most significant contribution to the field. He has
taught at Princeton, Stanford, MIT and Oxford, and is now University
Professor at Columbia University, Chair of Columbia's Committee on Global
Thought, and co-founder and Executive Director of the Initiative for Policy
Stiglitz was a member and chairman of the Council of Economic Advisers
during the Clinton administration, and later Chief Economist and Senior
Vice-President of the World Bank. In 2001, he was awarded the Nobel Prize in
economics and he was a lead author of the 1995 Report of the
Intergovernmental Panel on Climate Change, which shared the 2007 Nobel Peace
JOSEPH STIGLITZ is the author of, among other books, Globalization and Its
Discontents, Fair Trade for All, Making Globalization Work, The Three
Trillion Dollar War: The True Cost of the Iraq Conflict, with Linda Bilmes,
and his newest, Freefall: America, Free Markets, and the Sinking of the
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