A big reason most tea party Republicans — and there were exceptions, unfortunately — didn’t fear a debt ceiling crisis was not because they thought default inconsequential. They realized missing debt interest payments would be a big deal but thought Treasury had the ability and resources to make good.
What didn’t seem to scare TPRs, however, were the sudden and severe budget cuts that would have ensued had Congress failed to increase US borrowing authority. Just the opposite: those budget cuts would actually have boosted growth, they argue, by reducing the level of economic resources Washington was siphoning from the private sector. Wall Street’s take — that such austerity would eventually tank the economy — didn’t cut any ice.
Now there is evidence smaller government is good for growth over the longer run. But flash austerity would be quite an economic — and political — gamble to take when the economy is only growing at 2%ish, inflation is moribund, and unemployment remains highly elevated. And while TPRs think they have economic history on their side, that’s unclear.
1. TPRs point to the short and sharp 1920-21 depression as an example of a refreshing downturn, one where a fast recovery followed a needed liquidation after an inflationary wartime debt binge. Although the economy shrank by nearly 10% and unemployment rose from just over 1% to nearly 12%, the downturn was followed by the Roaring ’20s.
But more recent scholarship pegs the depression as really more of a bad recession with output falling by 3.5% and unemployment rising from 3% to just under 9%. More importantly, the Fed eventually responded with interest rate cuts. American University economist Daniel Kuehn: “The contribution of the Federal Reserve to the economic recovery follows unambiguously from comprehension of its contribution to the onset of the depression.” Would tea party Republicans want the Fed to respond to sudden fiscal austerity with more quantitative easing? Unlikely.
2. TPRs also point to US economic performance at the end of World War II. From 1944 to 1948, spending as a share of GDP plunged to 9% in 1948 from 44% in 1944. Devout Keynesian Paul Samuelson predicted such shock austerity would cause “the greatest period of unemployment and industrial dislocation which any economy has ever faced.” It didn’t happen. While unemployment did rise from artificial wartime lows,
George Mason University economist economist David Henderson of the Hoover Institution and Naval Postgraduate School points out that during the years from 1945 to 1948, it reached its peak at only 3.9% in 1946, and, for the months from September 1945 to December 1948, the average unemployment rate was only 3.5%. The private-sector gained as government retreated. While total output fell by 12% in 1946, private-sector GDP rose by nearly 30%.
As I have written before, such analysis provides useful insight into how free-market economies can adjust to shocks if government gets out of the way. But does the 2013 US economy — where net national savings as a share of GDP is close to zero — really look like the 1945 version? During the 1941-45 war years, over 22% of disposable income was saved, according to UCLA business professor Richard Rumelt. Not only did rationing limit consumer choice, but Americans were paying down depression-era debt and buying War Bonds. Rumelt:
When hostilities ended in 1945, many expected that an expanded civilian work force, plus reduced federal deficits, would bring back the depression of the 1930s. There was indeed a brief recession in 1946, but as production was rededicated to consumers and rationing was lifted, people rushed to replace rusted-out automobiles and broken-down refrigerators. The returning soldiers got jobs, moved to newly constructed housing in the suburbs, and the postwar boom was on. And it was greatly accelerated by households’ renewed capacity to take on debt.
3. TPRs also cite the 1990s economic boom. After the Cold War ended, overall federal spending fell to 18% of GDP in 2000 from 22% in 1991. Real US GDP, however, grew by 40% with an average annual growth rate of 3.8%. Case closed? Keep in mind that a) the spending reduction was only as a share of GDP — it rose in both inflation and non-inflation adjusted terms, b) took place over the course of a decade, and c) happened at the same time as a private-sector productivity boom. Of course, Henderson speculates that perhaps the decline in defense spending freed up knowledge workers to help make technological miracles happen in the private economy.
Maybe. But I don’t find this smattering of historical evidence persuasive enough to endorse sudden and severe budget cuts with interest rates at historical lows.(Even Rand Paul’s austere budget plan wouldn’t balance until 2018.) Given that the average US debt-to-GDP ratio was 37% from 1957 through 2007, a better policy goal would be to immediately shift — via entitlement reform and pro-growth polices rather than more discretionary spending cuts — the debt-to-GDP ratio onto a downward trajectory back toward that 37% level, if not lower, over the next two decades. That would be a far smarter and feasible agenda for Republicans and conservatives and libertarians of all types.