Robert Shiller summarizes the arguments for raising taxes and increasing government spending at Project Syndicate:
……while that [austerity] approach to debt works well for a single household in trouble, it does not work well for an entire economy, for the spending cuts only worsen the problem. This is the paradox of thrift: belt-tightening causes people to lose their jobs, because other people are not buying what they produce, so their debt burden rises rather than falls.
There is a way out of this trap, but only if we tilt the discussion about how to lower the debt/GDP ratio away from austerity – higher taxes and lower spending – toward debt-friendly stimulus: increasing taxes even more and raising government expenditure in the same proportion. That way, the debt/GDP ratio declines because the denominator (economic output) increases, not because the numerator (the total the government has borrowed) declines.
What he does not consider, however, is the message we are sending to government. In much the same way as bailouts increase moral hazard — with too-big-to-fail institutions taking on bigger risks secure in the knowledge that the taxpayer will bail them out if the bets don’t pay off — we encourage bad behavior from politicians if we allow them to raise taxes and increase government spending every time they screw up the economy. Federal government spending in the US economy has grown from 12.5% of GDP in 1950 to nearly 25% of GDP today. Seems like they are getting the wrong message.
That is like giving someone a promotion or a raise every time they mess up. When politicians fail, they need to get the right message — and not only at the next election. Cutting budgets when the economy is in recession is the right response, but how can we achieve this while saving the economy from a deflationary spiral?
The only way I can think of is to cut taxes and government expenditure, but encourage private investment in productive infrastructure through Treasury-backed low-interest or even interest-free development loans. These could be administered by an independently-elected infrastructure body with representatives from all parties. There are dangers, and the process would have to be closely monitored, but the risks are minor compared to rewarding failure.
Read more at Debt-Friendly Stimulus by Robert J. Shiller – Project Syndicate.
Colin
I take your point that the payment’s of benefits by governments above the tax base’s ability/willingness to pay is a disaster waiting to happen. I also agree that if many in the community have no surplus funds to increase cash flow then we have an equally difficult problem.
So we need to understand why economic spending is not behaving as it has in the past.
We know that there is plenty of demand in the economy. We know there is plenty of supply, and no restriction (mostly) in supply lines.
We also know that the cash in circulation is grater than at any time in history.
So what is missing at this point in history?
My belief is that it is as simple as to little spending power in the hands of those with the greatest demand.
What do you think.
Chris, Please use a spell check before posting, otherwise I have to.
The problem is not caused by inequitable distribution of wealth or incomes, it has an entirely different cause.
If you earn an income of $1000 per week, your credit is good and you can borrow from the bank so you spend $1050 per week. That $1050 is the income of your suppliers.
Along comes the GFC — caused by too much debt — so you decide to tighten your belt and repay the money you owe the bank. Now you earn $1000 and spend $950, using $50 per week to repay the bank. That means that your suppliers’ income is now $950/week instead of $1050 — almost a 10% fall. But every supplier is the customer of someone else, so your income falls as well. Which means that you earn say $950 instead of $1000. And if you still repay the bank $50 per week, your suppliers will only receive an income of $900 per week which will mean that you earn even less. That is called a deflationary spiral, where small changes in debt growth can have a large impact on incomes.