Spending cuts as stimulus

With all of the current emphasis on spending cuts as part of the agreement to raise the debt ceiling, the question has arisen as to whether or not reductions of federal spending will help increase economic growth and reduce unemployment. Sadly, this subject is frequently discussed in one or two sentences with the opinions limited to yes or no. Even Ben Bernanke today said that in the short run spending cuts would be neutral or negative with regard to employment. He never gave an opinion on the longer term effect; nor did he define what he meant by the short term. Somehoe, one would expect more from the chairman of the Federal Reserve, but instead we get short, half answers.

The proper response to the issue is that certain types of spending reductions will clearly help economic growth and increase job creation. Let me give an example: were the United States to reposition 30,000 troops currently located in Korea back to the USA, the level of federal spending would be reduced by billions of dollars each year. Further, the spending on these troops would be in the USA rather than in Korea. That extra domestic spending would actually increase American economic activity and jobs while reducing total spending. Since the principal purpose for the troops in Korea is to demonstrate the American commitment to that country, it would not be a big difference to limit the number of troops to a few thousand in that country. Another type of spending reduction that could increase growth are subsidies that distort economic activity. Ethanol subsidies actually raise the use of corn for fuel and thereby raise the cost of food and other prodcuts that use the corn as an ingredient. Getting rid of the subsidies would let the other products reduce their prices and could lead to growth in those areas. So the nature of the spending cuts is the first issue to be determined.

Some types of cuts will lead to fewer jobs in the near term. Bernanke is correct there. Obviously, if 50,000 federal workers get fired, there will be 50,000 additional unemployed. That does not mean, however, that a year or two later there will be more unemployed. Obviously most of those fired will get jobs. Then there is the issue of whether or not the actions of the USA in solving its fiscal crisis will increase the confidence of the business community enough to result in an increase in investment in the USA. That investment will do more for economic and job growth than the loss of the 50,000 jobs could ever cost. And that investment is something that will lead to growth year after year, literally the gift that keeps on giving.

The discussion above is just a tiny portion of the answer to this question. The real truth is that there is no simple answer. Those who want a pithy statement that explains all simply do not understand economics or the US economy or they have ADHD.