A budget freeze?

Here I offer some thoughts on President Obama’s new proposal.

Let me start with a statement of what I see as the core challenge facing monetary and fiscal policy at the moment. How can we successfully stimulate the economy in the short run and still maintain confidence in the longer-run reliability of the dollar and solvency of the U.S. government? In terms of monetary policy, the task is to persuade the public that the Fed will achieve 3% inflation over the next two years and yet subsequently contract its balance sheet sufficiently to prevent inflation from getting out of control afterwards. In terms of fiscal policy, the task is to support demand at the moment but then be able to phase out the fiscal stimulus over time as investment and net exports rise to take the place of government spending. Obviously this is not so easy to accomplish, but I feel that Carlo Cottarelli has been thinking along the right lines:

The challenge for policymakers is to formulate strategies for fiscal solvency– what we often call “exit strategies”– and communicate these strategies to the general public….

First, governments can reform their institutional fiscal framework to make it more likely that fiscal adjustment takes place when the time for action arrives. The precise framework will depend on country-specific circumstances. Possible reform options include fiscal responsibility laws, numerical fiscal rules (to take effect only when conditions normalize), fiscal councils tasked with monitoring fiscal developments, improvements in budgetary procedures, and increased fiscal transparency…

Second, various reforms in health and pension entitlements, though politically not easy, can be undertaken without jeopardizing economic recovery. These reforms will not have a large impact on the today’s deficit, but can dramatically improve long-term fiscal trends and signal commitment to fiscal sustainability.

Here is the New York Times’ description of the President’s new proposal:

President Obama will call for a three-year freeze in spending on many domestic programs, and for increases no greater than inflation after that, an initiative intended to signal his seriousness about cutting the budget deficit, administration officials said Monday.

The officials said the proposal would be a major component both of Mr. Obama’s State of the Union address on Wednesday and of the budget he will send to Congress on Monday for the fiscal year that begins in October.

The freeze would cover the agencies and programs for which Congress allocates specific budgets each year, including air traffic control, farm subsidies, education, nutrition and national parks.

But it would exempt security-related budgets for the Pentagon, foreign aid, the Veterans Administration and homeland security, as well as the entitlement programs that make up the biggest and fastest-growing part of the federal budget: Medicare, Medicaid and Social Security.

That sounds like a cosmetic and explicitly short-term approach to the budget problem, and therefore exactly the opposite of what we should be doing. The concern should not be the 2011 deficit, but the deficits in 2015 and beyond. But I see that others have found ways to put this more eloquently, so I outsource to my cyber colleagues:

Brad DeLong: this is a perfect example of the fundamental unseriousness of Barack Obama and his administration: rather than make proposals that will actually tackle the long-term deficit in a serious way– either through future tax increases triggered by excessive deficits or through future entitlement spending caps triggered by excessive deficits– he comes up with a proposal that does short-term harm to the economy as an alternative to tackling the deficit in any serious and significant way.

Paul Krugman: It’s bad economics, depressing demand when the economy is still suffering from mass unemployment…. It’s bad long-run fiscal policy, shifting attention away from the essential need to reform health care and focusing on small change instead.

King Banaian thinks the near-term fiscal contraction will in fact be insignificant:

The president is proposing a partial budget freeze that saves $250 billion over a decade…. That comes out to about 0.6% reduction in spending over a decade, and in the early years about $10-15 billion per year.

But in an update, Brad DeLong opines:

If it really is as small a deal as it now looks, it is not a budgetary and economic disaster– it is a rhetorical, political, and messaging disaster.


22 thoughts on “A budget freeze?

  1. Vangel

    Obama’s handlers must be total idiots. The freeze will do nothing for the budget because it will have a very small effect on the budget and is meaningless in the bigger picture. That means that it will not help the currency retain its purchasing power and will not help to fix the economy. What it will do is erode support for Obama on the left, which means that left of centre voters are likely to stay home when the Democrats are in trouble and need their supporters the most.
    If Obama had courage and brains he would follow the Harding example and cut federal spending and income taxes as much as possible. While that would lead the Democrats this year’s election it will allow the economy to bottom out and start recovering. By the time that 2012 comes around it should be strong enough to allow Obama to win a second term if he wished it. But that won’t happen. Instead of Harding, Obama will follow the big-spending, tax-increasing model of Hoover and FDR. As a result, the economy will contract and capital formation will slow significantly as those of means choose to stay on the sidelines and wait until there is a general improvement in overall conditions. That means that Obama runs the risk of losing the next election as he manages to accomplish what few people expected; he managed to make GWB look good.

  2. Brian Quinn

    I hope that what people glean from this whole brouhaha is that the budget simply cannot be balanced without cuts in defense, the rate of entitlement growth, and tax increases. Tax increases will be necessary regardless because of where debt service will rise to. At the current trajectory it will be close to $800 billion a year by 2020.

  3. GK

    Tax increases will be necessary regardless because of where debt service will rise to.
    An increase in tax rate would decrease tax revenue. The tax base is maxed out.

  4. Steven Kopits

    Once again you have anticipated what’s on my mind.
    The budget freeze is relatively insignificant economically, as you point out.
    It is significant politically, because it signals a shift from egalitarian to liberal (fiscally conservative) policies. That’s how badly Massachusetts rattled the Democratic party.
    Our analysis suggests the near future doesn’t get much better for the Democrats. Oil prices are creeping back to levels associated with reduced US oil consumption. If Morgan Stanley is right, and year-end oil prices reach $95, then I think the evidence strongly suggests the US will be shedding oil consumption, and I am skeptical that the economy can add jobs easily at the same time.
    If I were the Democrats, I’d be taking a close look at natural gas as a transportation fuel. It looks to me to be the only way to meaningfully lift energy constraints on the economy.

  5. Michael Krause

    Obama should be spending $500B on jobs TODAY building nuclear power plants, solar/wind generation fields, so we won’t be exporting $250B/y (or whatever the # is as it stands) to buy crude oil.
    Everything the current administration has done has been a joke. Like Fat man said, “rearranging deck chairs on the titanic.” A few billion for clean energy is no better than any Bush policy. I knew that the wool had been pulled over our eyes when the administration adopted the language “save or create.” BS from the beginning written by JDs.
    Then he should spend another $500B/yr to accumulate Chinese RMB reserves just to antagonize the hell out of the Chinese, as long as they are maintaining that peg at these absurd levels. That way we can buy back a competitive position.
    And if you are worried about the solvency of such a proposal, put caps on defense spending to $500B/yr, get out of Iraq, Afghanistan, etc. and move those military personel over to defend the nuke plants I suggested we build.
    Oh, that and give incentives to companies that set up telecommuting positions with employers where remote work is possible, and tax the hell out of gasoline.
    I guarantee you within 3 yrs tax revenues will have recovered sufficiently to tip the balances the other way.

  6. sjp

    GK: the most recent study I’ve seen on Laffer curves says that the US (and every other advanced nation, save Denmark and Sweden) is on the left side, meaning raising tax rates (on either labor or capital) is estimated to raise tax revenues.


  7. CoRev

    This freeze strategy has shown us that the “O” team is all about politics and not about helping (add your own list here.)
    Looking at the bigger picture, we have to thank “O” and his advisers for showing the US electorate the weaknesses of the Dem/Lib policies. Class warfare, demonization of business, spend and tax, environmental, energy, and redistribution of wealth cloaked in terms of fairness are now seen for what they are, based upon a nonexistent reality.

  8. Tom

    I agree with Fat Man, especially if by “Titanic” he means the Democratic Congressional majority. I say as a committed Democrat of the sadly rare and endangered fiscally conservative variety.
    If we’re looking at this freeze as political strategy, and I think that’s the only way to look at it, it’s much too little, much too late. Obama committed political suicide by taking political ownership of the deficit and bailouts, starting in 2008 when he helped rally Congressional Democrats to sign big blank checks for Paulson and Bernanke to bail out everything indiscriminately, and culminating with the ARRA and the agreement with Bernanke for the Fed to fund public spending. The vast majority of American voters, even Massachusetts voters, don’t believe the Keynesian theories (or more accurately, perpetual motion machine fantasies) espoused by DeLong and Krugman. Obama has belatedly realized this and woken up to the fact that he is heading for disaster this November. But he still hasn’t got the nerve to go against his party’s leftist wing in any significant way. And he’s probably already out of time anyway.
    The US federal government is already spending roughly twice its income, or 2.5 times if you regard the Fed’s purchases of MBSs and GSE debt as de facto federal government spending.
    There is still a huge international store of trust in the US government, its bonds and its currency. That “Titanic” isn’t about to sink anytime soon. But don’t imagine for a second that it’s unsinkable. China’s previously rapid accumulation of Treasuries has been on hold since May. As the US deficit must increasingly be funded domestically, it sucks up the Fed’s monetary stimulus and negates its stimulutive value on private lending, leaving only its inflationary component intact.
    We have used up the stimulative value of fiscal and monetary stimulus, and now austerity is inevitable. You can have smaller amounts of nasty-tasting medicine for a longer time or more for shorter, take your pick. Sorry if funny old uncle Paul keeps telling you differently, there is no more pie.

  9. tj

    Don’t overlook the fact that any freeze at current spending levels ignores the huge increases in G spending over the last few years. The left and right are shifting our attention toward a balanced budget. The arguement really needs to be framed in the context of total debt management. I’m not saying we need to completely eliminate the national debt, but a long run plan to reduce it, as a fraction of GDP, would be well received, imho.

  10. Bob_in_MA

    I think this is less important than the prospects of the next round of stimulus measures. The House barely passed it’s $150B jobs bill in December. Given the change in mood, it seems anything close to that will be next to impossible to get through the Senate.
    Cynical Republicans have a pretty strong hand here, voting down new spending let’s them play the fiscal responsibility card, and the worse shape the economy is in November, the better they will do in the election.

  11. Terry

    We thought we elected a leader who would challenge the corrupted political system. Instead, we elected a petty politician who is feckless even in being part of the corrupted system.
    This is not disappoint, this is a disaster that will literally cost us for many decades. Japan may be the “best case” outcome–and it’s not over over there.

  12. RicardoZ

    Anyone who tells you they know where we are on the Laffer curve doesn’t understand the Laffer curve.

  13. Cedric Regula

    I read Krugman’s and Delong’s blog too, just to make sure I know what all economists worry about.
    I’ve give the bullet point summary here:
    1)The government isn’t spending enough money.
    2)The Fed isn’t lowering interest rates enough.
    3)The “Richest Country in the World”, meaning us I guess, doesn’t have national health care.
    4)Big banks suck, and something should be done about that someday. (Before the banks hand the Treasury or Fed the rest of their “assets” for cash, I presume)
    6) Obama is a right wing conservative.
    5) And lastly and firstly, why hasn’t government used their power to create sustainable employment??? (This power being proven and well documented, I would have to presume, again.)
    So now we know what the problems are.

  14. Vidal

    The move is political, not economic. The administration is obviously trying to address the droning “huge deficits are impinging our freedom” mantra that is eroding his political capital. Obama has expended the political capital necessary to institute the reforms the economically informed are hoping for. If you want to get mad at something, get mad at this 60 votes garbage in the Senate.

  15. Mike Laird

    JDH, would you know a “green shoot” if you saw one? You have written about the inflation dangers of deficit spending. So when a small step is made towards reducing the deficit – you complain?? Yes, I know much larger spending reductions in Medicaid, Medicare, and Social Security are necessary. But if Obama’s announcement had been budget increases, you would have complained about inflation. So lets face it, you are not acting like an economist on this topic; you are acting like a politician. So please stop. I’d like to hear some macro (or micro) economic analysis of this budget freeze, and some economic thoughts on next steps to get this country where we need to be.

  16. sjp

    Mike Laird: economists predict the effects of economic decisions and put them into context. That’s what JDH is doing. In a crude analogy to what JDH is doing, he’s pointing out that a caffeine-addicted meth-addict has bigger problems than cutting back on Starbucks.

  17. KevinM

    I have spent nearly twice my income this year by taking short term debt that has to be rolled over periodically. I plan to do the same this year, too. Interest rates are at generational lows, so I expect the cost of the debt to increase. I have no savings. So here’s my plan:
    Starting next year, I will cap expenses on about a third of my budget at current levels. And I will make painful cuts that trim my total expenses by about 3 percent.
    I think this is going to work out really well for me!

  18. Cedric Regula

    The rest of the news is in:
    It’s Official: Democrats Succeed In Pushing New Debt Ceiling To $14.3 Trillion
    Democrats had to scramble to approve the plan, which means they won’t have to vote on another increase until after the midterm elections this fall. To win the votes of moderate Democrats, President Obama promised to appoint a special task force to come up with a plan to reduce the deficit. The House must still vote on the measure before it’s sent to Obama for his signature.
    So by November we will achieve 100% debt to GDP !
    Only in America can you announce a $15 Billion/year budget freeze (note that is NOT a reduction), scheduled to start next year(ok,fiscal year) and simultaneously a $1.9 Trillion increase in the debt ceiling, after just increasing the debt ceiling less than 40 days ago. And it runs out before the end of this calender year!
    That makes us tied with Greece and Italy by early 2011, unless they find some way to keep pulling ahead. Has anyone picked the location for next year’s Winter Olympics? Davos perhaps? Maybe we can turn this into a sport?

  19. Get Rid of the Fed

    Cedric Regula, here is how I like to look at the situation (including the budget).

    If the spoiled and rich can’t get the lower and middle class to go further into debt to prevent price deflation and asset price deflation while “stealing” the lower and middle class’ retirement, then the spoiled and rich will get their gov’ts to do it for them.

  20. Anonymous

    In respsonse to Mike Laird and sjp:
    I think what professor Hamilton is saying that in the short run it might not be a bad idea to actually consume more caffeine because it can eventually help you quit meth in the long run.

  21. David Smith

    Enjoyed the comments of Tom and RicardoZ in particular. Also all those who get the fact that this is very small cut off a wildly inflated base. The doors of the Treasury have been wide open for years; this is closing them by an inch or two, nothing really.

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