This month marks the two-year anniversary of the end of recession and start of recovery. But it’s a recovery in name only, so weak as to be nonexistent. And it has been weak from the start. Real GDP growth has averaged only 2.8 percent per year compared with 7 percent after last deep recession in 1981-82, as shown in the following chart. And the unemployment rate is still over 9 percent.
Today the Joint Economic Committee of the Congress held a hearing on whether a credible plan to reduce government spending growth would bolster or hinder the recovery. I argued that a credible budget strategy would strengthen the recovery, by removing the threats of another fiscal crisis, higher taxes, higher inflation and higher interest rates—all caused by the huge deficits and growing debt and all impediments to private investment and job creation (written testimony here and opening remarks at C-Span 6:23 minutes here). To balance the budget without increasing taxes the plan would have to reduce spending growth by $6 trillion over ten years.
Fortunately, there are some signs of progress: The election last November sent a message to Washington to reduce the deficit and the debt; the 2011 budget deal reduced 2010-2011 growth in discretionary budget authority from +$39B to -$39B; President Obama withdrew his first budget proposal for 2012 and is agreeing to less spending; and the idea of tying the debt limit hike to reductions in spending growth is holding, despite protests from the Treasury Secretary and the Fed Chairman.
One way to implement a credible budget strategy in our current divided government would be to agree now to reduce spending by $2.5 trillion over ten years (including material changes in 2012) as part of the $2.5 trillion debt limit hike, and then debate how to deal with the remaining $3.5 trillion gap in the presidential election. One side would say to close the gap by raising taxes. The other side would say to close the gap by reducing spending. While the outcome would still be uncertain, there would be far less uncertainty about the budget than currently exists.