Fiscal Cliff Notes

Some of my (somewhat well-educated) thoughts on the fiscal cliff:

1) The fiscal cliff is NOT the point at which the government runs out of money. Somehow this has become the widespread notion of what the Fiscal Cliff is, descriptively. Remember, the issuer of a currency cannot run out of that currency. The U.S. government, as issuer of the dollar cannot run out of dollars.

2) The fiscal cliff IS the point at which spending cuts kick in and tax cuts expire so that the deficit closes. That is, (G - T) becomes smaller. Every economist understands that this will hurt the economy because it contracts overall spending in the economy. GDP = C + I + G + (X-M). So if Taxes go up, our spending (Consumption and Investment) will go down and if government spending goes down, overall GDP will drop unless somehow we miraculously become a large net exporting nation.

3) Knowing this, we still think we have to shrink the deficit. I detailed this a couple of weeks ago, so I recommend reading that piece. IF we let the fiscal cliff happen, the economy will shrink quickly. If we reach a deal, the economy will sputter and will likely fall some if not a lot--it depends on the magnitude of the deal.

4) We need a larger deficit! This can be accomplished through spending increases or tax cuts, but the only way to actually shrink the deficit is to increase GDP. The private sector is still deleveraging, the foreign sector--our trading partners--is in poor shape, and so the only institution that can help is the government. Otherwise we're in for a long, slow deleveraging period--see The Great Depression. This is needless because the government has policy tools to prevent it, and it doesn't necessarily have to mean a concentration of government power.

5) What we spend money on matters! Some spending has a higher multiplier effect or employs more workers. Much spending is extremely wasteful and so wouldn't do much to help our society or our economy. All spending will benefit some more than others. Some spending is immoral. We need to make these decisions as a society in the political arena, but note these decisions have economic effects--see my most recent post on this.

6) We have a particular duty to look out for those left behind or trampled on by the system. We can do this personally and through institutions--including Churches, non-profit organizations, local governments, and the federal government. All have advantages and disadvantages, but all are needed according to the principle of subsidiarity, which is not a limiting principle (thinking of it solely as a principle that limits the size of government), but is rather a cooperative principle (thinking of it in terms of all institutions of all sizes working together to accomplish the common good).

Stimulus and State Budgets

A big problem with federal stimulus spending is its inefficiency. It is terribly slow in being spent and is often spent in unhelpful ways (such as unnecessary, unproductive jobs or construction projects that are less helpful than education, police, and fire department spending). Note: This is certainly debatable, the main point is that government spending is often less effective and efficient than private spending because of incentives and bureaucracy.

But consumers (the "private" sector) won't spend, mainly because they don't have jobs and are deleveraging, or paying down the debts they incurred in the build up to 2008. So in order to push the downward cycle the other way, the government has to spend and create jobs.

State governments are currently up against the wall with their budgets. They don't have the flexibility with deficits that the federal level has because they don't have control over the currency. So why not give the money to the States? They will certainly spend it more quickly and efficiently. It will likely go to needed areas to prevent cuts and not to add additional spending. This will enable policemen, teachers, firefighters, and other government workers to keep their jobs and prevent a rise in crime rate or a drop in education quality which further depress our economy.

From a Catholic Social Teaching perspective, this would be an excellent application of the "subsidiary function." The Federal government would allow the lower institution to do its job by providing it with the necessary funds. Once tax revenues kick back up, then the Federal government can pull out its funding and the States can resume independent financial operations. There is no federal take over or increase in big government. Stimulus funds will do what they should, prop up the economy until the private sector can lead the charge again.


For more read "The Real Job Killers? State Budget Crises"


For those concerned about deficits read:
Myths about the Deficit, Part 1
Myths about the Deficit, Part 2
Seven Deadly Innocent Frauds
Keep the Deficit, Ditch the Doves