Three Possible Outcomes of Fiscal Imbalances
Brad DeLong gives us an excellent discussion of some fiscal policy possibilities:
If we were going to get concrete, and, say, take the Bush tax cuts of 2001 and 2003 and try to assess their dynamic supply-side effects within a model in which the government budget constraint is satisfied as it will be satisfied, what would we have to do? I believe that we would have to model the satisfaction of the government budget constraint as a probabilistic combination of three different possibilities:
- Recognize that there is a chance that the tax cut will be reversed. Perhaps once again, as in the early 1990s, an unwillingness to cut spending combined with mounting debt and debt servicing costs changes the complexion of politics. I would have said that the chances of this are high given the 7% of GDP long-run fiscal deficit that America appears to have, and the unwillingness of any politician to propose cuts in the growth rates of Medicare and Social Security spending. But the chances of this have dropped since Kerry reached his peak bubble value of 80% on the Iowa Electronic Markets Tuesday afternoon.
- Recognize that there is a chance that there will be a long period of rising debt and debt burdens accompanied by cutbacks in spending shares as various institutional mechanisms force the legislature to face and try to meet the government budget constraint. We know what George W. Bush thinks of the pay-as-you-go mechanisms that restrained Congressional action so effectively in the 1990s: he thinks they are a joke: “You know what pay-go means? It means you pay–and [Kerry] goes and spends!” I would say that the chances of this have also dropped since Tuesday afternoon.
- Last, there is the remaining possibility: that the government budget constraint itself will take its own non-policy steps to make sure that it is met, and generate an Argentina-style meltdown. By the principle that probabilities sum to one, I conclude that the chances of this have risen since Tuesday afternoon.