So what is Mitt Romney’s big idea about how to increase economic growth? Top economic adviser Glenn Hubbard gives a pretty big hint in the Financial Times today that his boss isn’t some sort of closet, old-school Keynesian:
While a growth-focused agenda would have many parts, two fiscal policy issues stand out – getting our fiscal house in order and reforming the tax code. The US is on an unsustainable fiscal trajectory, with a debt-to-gross domestic product ratio projected to rise to second world war levels in the coming years. High and rising debt burdens are a structural impediment to growth. They raise expected future tax burdens, discouraging investment and limiting productivity growth. … Gradual fiscal consolidation may also be stimulative in the short run. Research by Hoover Institution economists concludes that reducing federal spending relative to GDP to pre-financial-crisis levels over a decade would increase GDP in the short and long term. This outcome reflects lower future tax rates and the boost from lower interest rates to investment and net exports.
In other words, Hubbard suggests American-style austerity — cutting spending and debt without raising taxes — and the policy certainty it brings can lift growth both in the short and long term.
And since Hubbard mentions the Hoover study, I decided to take a look at the 32-page analysis. (A key chart from the study is at the top of this post.) Here is the key section looking at the relationship of spending cuts on near-term economic growth:
A big question is whether the reduction in government spending reduces GDP in the short run, a concern that has been raised by many economists and policy makers. … According to the initial model simulations, the strategy increases GDP in both the short run and the long run relative to the baseline.
There appear to be three sources of this positive effect. First, lower levels of government spending in the future, compared to the baseline, imply lower tax rates which provide incentives and stimulate employment.
Second, the expectation of reduced government spending in the future lowers interest rates, which stimulates demand today offsetting the decline in government spending in the short run.
And third, the lower interest rate reduces the exchange rate thereby increasing net exports which also offset the decline in government spending. More generally, the gradual and credible decline in government spending allows the private sector to adjust smoothly to the decline in spending without negative disruptions.
Indeed, the plan modeled by the Hoover academics would begin cutting spending immediately, though gradually, in 2013. If Romney wants to present research that supports his plan to a) balance the budget and b) cap spending at 20% of GDP — this is it.
The Hubbard op-ed and the Hoover study certainly suggest that a President Romney would impose austerity on Washington in order to create prosperity on Main Street. Less government, more growth.