That was Then, Feb 2004

That Was Then Joseph E Stiglitz. The American Prospect, Feb 2004 Deficit reduction worked for Clinton, but circumstances were different in 1993. Today's Democrats mustn't think they can merely mimic him. WE LIVE IN AN UPSIDE­DOWN WORLD where Republicans defend deficits and Democrats attack them. These are seemingly opposite views. But both have led, mistakenly, to cuts in social investment as well as to needlessly slow economic growth and high unemployment. For years Republicans tried to slay Keynesian economics, the idea that in an economic downturn, one should run deficits. During the Clinton years, they even pushed for a balanced­budget amendment to the Constitution, which would have enshrined the principles of fiscal prudence (and precluded the Bush deficits). In those years, the Democrats were accused of being fiscally irresponsible because they sensibly believed that in times of recessions, a deficit was good policy. All of this has changed. Ronald Reagan, of course, did run huge deficits, but that was supposedly a mistake. In his "voodoo" economics, tax cuts were supposed to somehow generate more tax revenues, so there was not supposed to be a deficit. Under George Bush Senior, taxes were raised to correct Reagan's error. But George W. Bush unabashedly defends huge, endless deficits. As a form of economic stimulus, all deficits are not created equal. The economy may be temporarily booming, but Bush's tax cuts were not designed primarily to provide an effective stimulus but, rather, to reduce taxes, mainly on the wealthy, as an end in itself. But tax cuts for the poor, or better unemployment benefits, are far more effective in stimulating the economy. Public investment­in, say, roads, airports, education or technology­would have provided much more stimulus in the short run and enhanced America's productivity in the long run. The new Republican economic logic also insists that prolonged deficits do not produce significant increases in interest rates. This logic defies the usual laws of supply and demand, in which an increase in demand (here the demand for funds by the government) leads to an increase in price (here the interest rate). Accordingly, by this logic even enormous and structural deficits do not adversely affect growth. This view is nonsense, but Democrats make a mistake when they respond by embracing the old Republican role of deficit hawks. In a downturn, tax revenues normally decrease, so deficits increase. During a recession, therefore, it makes sense to tolerate and even to increase these deficits, to stimulate economic activity and recovery. But the new Democratic recipe is something along the lines of, "Reduce the deficit and economic prosperity will be restored." Emboldened by the seeming success of that formula in the early 19905, and the seeming failure of the opposite strategy by Bush, many Democrats believe fiscal prudence will cure both the economy and their fiscal reputation. But, unfortunately, the wrong lessons have been drawn from both experiences. DEFICIT REDUCTION UNDER BILL Clinton worked, both because of the peculiar circumstances of the time and because of the way it was carefully crafted. For a variety of reasons­including regulatory mistakes that contributed to the economic recession in the first place­banks had larger than normal portfolios of long­term government bonds. So the lowering of long­term interest rates­which increases the