Step 2: ???

Many years ago, when I was 10 or 11 I had a friend of mine sleepover. My parents had something going on that night, so we had a babysitter for a few hours. She was quite lenient on us, and being young boys, we took advantage of the situation. I'm not sure I've drank more pop over a span of a few hours than I did that night. We also convinced her to let us watch a banned cartoon that night.

I'm not sure why I remember that night so well, but every time I hear a politician or pundit talking about reducing the deficit I can't help but think of the episode I saw that night. You see, the episode I saw was about the "underpants gnomes" who'd go around at night stealing underpants.

They had quite the business model (I'd offer a link here, but I could not find a clip containing no vulgarity, so peruse at your own risk if you like):

Step 1: Collect underpants
Step 2: ???
Step 3: Profit!

For these politicians and pundits, it seems that their modified plan for the economy could be:

Step 1: Reduce deficit by cutting social programs and raising taxes
Step 2: ???
Step 3: Growth!


I have yet to hear a solid explanation of what reducing the deficit would do for the economy to help it grow. The best, or most feasible explanation offered is that businesses would be more confident and would start spending and investing to create jobs. Yet, this magical step two (what Krugman calls the confidence fairy) has some problems with it.

What about reducing the deficit increases business confidence? Reducing the deficit will reduce their sales, because the deficit measures the amount of money leaving and entering the economy over time. A deficit is money entering the economy, a surplus is money leaving. Lower sales do not boost confidence.

What about more stable policies? Sure! Stability in Washington is very important, but you can provide stability without reducing the deficit.

Business investment relies greatly on expectations of future sales. For that, businesses need stability and expected stability. They need to know roughly what wages, resources, healthcare, etc. will cost. They also need to have a rough idea of what they can sell at what prices to make their investment worthwhile. Banks also form their expectations when deciding whether to give out loans or not.

For this, we need Washington to stop kicking the can down the road, to stop passing temporary measures while they continue to disagree over how to reduce the deficit, and they really need to stop threatening to go "over the cliff" or fall into voluntary bankruptcy. This is what makes businesses uncertain, not the deficit. Constant fiddling by Washington must stop if the private sector is going to have any confidence in their bottom line.

The deficit should be reduced, but not directly. It will be reduced with a growing economy. To grow the economy you need to boost spending, which means a higher deficit now. A higher deficit now will equal a lower deficit later with economic growth.

The deficit should be directed toward those who need it most and who will be most likely to spend it. Not big business and not big banks. Not those who own big businesses and big banks. Give it to those who need it and they will spend it. This, in turn, will boost the sales of businesses, small and big alike. They will be more confident of future sales and will invest in more jobs.

Remember that the public sector deficit is the private sector surplus. If we reduce the public deficit, then we reduce the private sector surplus.

There is no magical step 2 to get us growth if step 1 is reducing the deficit.