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The Fiscal Austerity Trap:

How Budget Deficit Hysteria Risks Sabotaging Growth


& Creating Self-Fulfilling Budget Difficulties

Thomas Palley
New America Foundation
Mail@thomaspalley.com
Introduction
• Return of fiscal austerity agenda = case of
“Déjà vu all over again”.
• Wrong economic agenda.
• Wrong political agenda.
Why We Need Sustained Deficit
Financed Fiscal Policy - 1
• (1) Keynesian stimulus to fight the
recession.
• (2) Help private sector deleveraging.
• (3) Spur economic growth.
Figure 1. The “virtuous” circle linking growth
and deficit financed public investment.

Growth

+ +

Deficit financed
public investment Fiscal space
+
What is a Sustainable Deficit?

• Sustainable deficit keeps steady


debt/GDP ratio.
(1) With growth of 2.5% & debt/GDP ratio of
100%
 sustainable deficit = 2.5% of GDP.
(2) If real interest rate = 2%  implies
interest service burden of 4%.
Is Our Current Budget Situation Sustainable?
Table 1. Projected annual average budget deficit as a percent
of GDP, 2009 –2050. (Source: Kogan et al., 2008)

2009 - 2050

Annual average deficit/GDP -4.2%

Letting Bush-Cheney 2001 & 2003 tax +1.9%


cuts expire in 2010
= -2.3%

Holding health care cost growth equal +3.0%


to per capita GDP growth
= +0.7%
Conclusion - 1
• Fiscal austerity based on flawed economic
analysis & is not supported by the numbers.
• Need budget deficits to:
• (1) Fight recession.
• (2) Help private sector deleverage
• (3) Spur growth via Public Inv.
Conclusion - 2
• Fiscal austerity will do triple damage:
1)Risk economic stagnation & sub-par
growth.
2)Make economic reform more difficult.
3)Uses budget deficit as Trojan Horse to
justify an assault on vital public programs –
especially Social Security.