Dollars and Sense

The Washington Post editorial board is right on target in their warning about U.S. fiscal policy.

The problem is that nobody believes Mr. Snow's rhetoric. He reiterated the administration's plan to cut the deficit to less than 2 percent of gross domestic product, down from 3.6 percent last year. But this plan leaves out the cost of operations in Iraq and the general war on terrorism, and it assumes no reform of the alternative minimum tax and no rise in federal spending. Using more plausible assumptions, the Center on Budget and Policy Priorities expects the budget deficit to hit a low of 2.5 percent in 2010 and then start rising again.

Economically speaking, this carelessness about the budget and current account (trade) deficits may be due to a radical monetarism on the part of the administration. If we escape a serious recession, they will be proved right. However, I join most economists on a middle road saying that even a perfect monetary policy cannot redeem irresponsibility on the fiscal side.

If we do have another major recession (or depression), it could lead to another shift in political economic thought. The Great Depression brought about Keynesianism; the Stagflation years swung the pendulum over to monetarism and supply-sidism; a new economic disaster could send it back to counter-cyclical spending and deficit management. A good understanding and responsible action on both sides would be nice, but perhaps that is too much to ask.