The Intransigent Tea Party and Germans

Intransigent. That is the adjective that is commonly applied these days to members of the Tea Party and to the Germans.

This adjective is applied to members of the Tea Party because they adhere to the principle, enunciated most vociferously by Grover Norquist, that taxes must not be raised and spending must be cut. Just this last Sunday on CNN, Senator Patty Murray, Democrat Co-Chair of the Joint Select Committee on Deficit Reduction, said: “Republican lawmakers ... feel more enthralled with a pledge they took to a Republican lobbyist than they do to a pledge to the country to solve [America's debt and deficit] problems.”

This adjective is applied to the Germans because they refuse to support the idea that the ECB should buy up all the debt of the various EU countries (for example, Greece, Italy, and Spain) that have spent and borrowed themselves to the brink of ruin. This week's Economist puts it succinctly: "Far better, goes the standard German line, to remain principled and just say no."

A similar criticism made of members of the Tea Party and Germans is that they are "moralizers," viewing excessive spending, borrowing, and the defaults that result therefrom as "sins" that must be expiated through the "pain of austerity," which serves as a "purgative" or "punishment" for the fiscal excesses. For example, back in September, Paul Krugman wrote:

"What Mr. Trichet and his colleagues should be doing right now is buying up Spanish and Italian debt ... In fact, the E.C.B. started doing just that a few weeks ago, and produced a temporary respite for those nations. But the E.C.B. immediately found itself under severe pressure from the moralizers, who hate the idea of letting countries off the hook for their alleged fiscal sins. And the perception that the moralizers will block any further rescue actions has set off a renewed market panic."

Let's be clear. I certainly agree with Mr Krugman that austerity measures will cause short term pain. This is because, over the short term, austerity measures always result in lower aggregate demand, which causes the economy to grow more slowly. But does this mean that we should instead engage in short-term stimulus to increase aggregate demand?

The problem is that the argument that short-term stimulus should be applied to an ailing economy is a sound one only for a government operating under "normal circumstances," where normal circumstances are defined as

a.) the government is not already burdened with debt from having taken on enormous social obligations and having run chronic deficits for the last 30 years, and

b.) the government has demonstrated over multiple business cycles that, when the economy starts to roar and tax receipts are running high, it will withdraw the stimulus and reduce its spending and borrowing to apply a counter-cyclical dampening influence on the economy and will set aside certain amounts of money to tide it over during future downturns.

But, this is never the way American government works. When the economy is roaring and tax receipts are high, that is precisely the time when federal and state governments ramp up their social spending and borrowing even further and take on even greater social obligations to their citizens. At such times of prosperity, the need for austerity measures, for reducing debt, and for saving, is forgotten.

Thus, the problem with the Keynesian approach is not chiefly a theoretical one, but a practical one. There are two sides to the Keynesian coin: short-term stimulus during hard times, and counter-cyclical fiscal tightening during good times. But for modern Keynesians there never, in fact, comes a time when the austerity measures are applied and spending and debt are reined in. Instead, ever expanding government spending and borrowing become a permanent way of life. And what is worse, the government spending is often the kind of spending that has an abysmal return on investment. The end result of this process is that, as the years roll on, mountains of debt are piled up while the return on the spending funded by that debt becomes less and less. We owe more and more and get less and less in return.

Laurence Fink, chief executive officer of BlackRock, said recently in a Bloomberg interview:

"Germany is playing their cards really well. ... We have seen two changes of government. Governments are working towards constitutional amendments to balance the budget. You have unions in Spain now talking about restructuring wages. So, you have countries like Spain and Italy that are finally now responding to the global capital markets. And Chancellor Merkel saying "We're not doing anything" and the ECB following suit has had some very good results. Now, obviously, the capital markets are not happy about it. We're getting really stressed about it. But, I think there has been positive movement in these countries. It is a very dangerous stake that Germany is playing.

Yes, it is a dangerous game that Germany is playing and, over the short term, there will continue to be stress in the capital markets and pain as the profligate economies get their fiscal houses in order. But, our only hope is that Germany, and the Tea Party here in the US, intransigently adhere to their principle that profligate spending and borrowing must stop. That is the only thing that can pull us back from the brink. Following the prescriptions of the Keynesians is like following the prescriptions of some mad doctor who claims that curing a heroin addict of his addiction will cause too much short term pain, so that what we must do instead is give him more heroin.