Highly effective fiscal policy, even at the zero lower bound on interest rates, remains at best a theoretical possibility, subject to severe political constraints. While fiscal consolidation may imply some short-term costs, especially in a recession, the long-term costs of delay are large.
STANFORD – Around the world, raging debates about whether, when, how, and how much to reduce large budget deficits and high levels of sovereign debt are dividing policymakers and publics. Diametrically opposed spending, tax, monetary, and regulatory policies and proposals are proliferating. To consolidate (the budget), or not to consolidate, that is the question.
The political left clamors for more spending, higher taxes on high-income earners, and delayed fiscal consolidation. For example, the economist and New York Times columnist Paul Krugman proposes waiting 10-15 years. (Many of the same people argued for analogous reasons against the Federal Reserve’s successful disinflation policies in the early 1980’s.) The political right calls for more rapid deficit reduction by cutting spending.
In Europe, policymakers, including the European Central Bank, demand consolidation for high-debt countries, but are flexible in negotiations; voters, however, reject it – most recently in Italy. In the United States, Republicans propose to balance the budget within ten years by reforming entitlement spending and taxes (with fewer exemptions, deductions, and credits providing the revenue needed to reduce personal tax rates and a corporate rate that, at 35%, is the highest in the OECD).