The improving U.S. economy will make absolutely no one forget the Long Boom of the Reagan-Clinton-Gingrich years. Wage growth is stagnant, and too few Americans are working. As Paul Ryan, the new chairman of the House Ways and Means committee, said yesterday, “The latest job report is the nicest car in the junk yard.” Still, it’s also clear that GDP and job growth have finally shifted to a higher gear. So does anyone in Washington deserve even a smidge of credit for the upturn? In my new The Week column, I throw gallons of cold water on the dubious notion that Obamanomics is the reason for this new season of prosperity (such as it is). Sorry, Democrats.
But what about Republicans then? Senate Majority Leader Mitch McConnell, in savvy bit of Twitter-esque trolling, recently suggested the mere expectation of a GOP takeover of Congress revived America’s animal spirits. A more serious argument is that the GOP House deserves a pat on back for pushing budget cuts, via the 2011 Budget Control Act. As (a) government spending has declined (from 23.4 percent of GDP in 2011 to just over 20 percent last year) and (b) the annual budget deficit has shriveled (from over 8 percent of GDP in 2011 to under 3 percent last year), we’ve seen (c), economic acceleration. Anti-tax crusader Grover Norquist recently tweeted: “Mr. Keynes, explain why economy grows when we stopped doing “Stimulus” and did “Sequester” instead.”
So what should we make of that interesting correlation? Does it prove causation? Is this a shining example of “expansionary austerity?” New research from economist Alberto Alesina – perhaps the most noted proponent of the idea that fiscal retrenchment can boost growth — suggests the answer to those questions is “No.” In the paper “Austerity in 2009-2013,” Alesina finds that austerity mesures “based upon cuts in spending are much less costly, in terms of output losses, than those based upon tax increases.” So if you are looking to cut debt, spending cuts hurt GDP less than tax hikes. Good to know. While both pull demand from the economy, one is less distorting of incentives to work, save, and invest.
But finding that spending cuts hurt growth less than tax hikes is not at all the same as finding spending cuts actually boost growth in the short term. (Over the long-term, we want to minimize government’s take.) While sometimes “cut to grow” does work, Alesina notes, it’s usually when accompanied by pro-growth policies or reforms. And that’s what happened in the U.S. the past few years. Austerity — both budget cuts and tax increases — were offset by massive monetary easing by the Federal Reserve. Add in cheaper energy and the natural recuperative forces of a free-market economy, and you get a modest economic resurgence.
In a way, spending cuts and easy money are a good combo during a time of economic weakness and rising debt levels. In this case, though, it would have been better had the spending cuts been more concentrated in reducing future entitlement obligation rather than current discretionary spending. Of course, many Republicans have been critical of the Fed’s unorthodox actions. Now it’s time to figure out how to turn this boomlet into another Long Boom.
— James Pethokoukis is the DeWitt Wallace Fellow at the American Enterprise Institute and an official CNBC contributor. You can follow him on Twitter at twitter.com/JimPethokoukis.