Analysis: Doomed budget amendment could leave economic scars

WASHINGTON Wed Jul 20, 2011 8:11am EDT

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WASHINGTON (Reuters) - A balanced budget amendment backed by top Republican presidential candidates is not likely to see the light of day, but the gusto for spending cuts it represents may damage an already fragile economic recovery.

The proposed constitutional amendment, backed by prominent presidential hopefuls like Mitt Romney and Michelle Bachmann, is part of a broader fight over U.S. debt that could lead to a default on government obligations.

Though the amendment is likely to fail, Republicans are planning a separate initiative to slash $3.75 trillion from the budget over ten years in exchange for raising the U.S. debt ceiling.

In times of economic crisis, it is standard practice for governments to increase spending to stimulate economic activity. The Obama administration tackled the 2007-2009 with a nearly $800 billion stimulus plan.

A group of prominent economists, including Nobel laureate and rejected Fed board nominee Peter Diamond, on Tuesday published a letter condemning the Republican amendment proposal. They said such initiatives could thwart the government's flexibility during economic downturns.

"There is no need to put the nation in an economic straitjacket," the letter said. "A balanced budget amendment would mandate perverse actions in the face of recessions."

The Senate could vote on the amendment this weekend, but it is expected to fail in the Democrat-led chamber.

There is no vote scheduled in the Republican-controlled House of Representatives, but the House will vote on Tuesday on the initiative to slash $3.75 trillion from the budget.

Uncertainty over the debt ceiling, which has sparked warnings from top rating agencies that the U.S. government could lose its prized AAA credit rating, follows a tumultuous first half of the year for the economy.

"FOOLHARDY"

The recovery slowed sharply during the first six months of 2011 and the job market took a turn for the worse.

Against that backdrop, many economists are warning that sharp cuts in government spending -- if made too soon -- are the last thing the country needs.

A legal restraint that would prevent the government from taking action in times of recession would be even more reckless, they say

"It seems foolhardy," said Oscar Gonzales, economist at John Hancock Financial Services in Boston. "It really undermines your ability to make good macroeconomic policy."

Proponents of the balanced budget measure say high levels of government debt inhibit private sector borrowing, and contribute to long-term uncertainty that makes both consumers and businesses leery of spending.

But even if the policy goal is to eventually reduce the debt, many analysts say bolstering employment should be the top priority now, since that is the quickest way to increase revenues, and that near-term fiscal stimulus could help.

A heavy combination of fiscal and monetary stimulus helped lift the economy out of recession in the summer of 2009, and Fed Chairman Ben Bernanke has warned steep near-term spending cuts could threaten the U.S. recovery.

President Barack Obama has proposed combining a long-term budget cut plan with an immediate extension and expansion of a payroll tax credit for U.S. workers.

U.S. employment has stagnated over the past two months, and the jobless rate climbed to 9.2 percent in June.

A Reuters poll published last week showed private forecasters pulling back on their estimates for the economy's rate of expansion in 2011 to 2.5 percent.

The survey also found that, between Europe's financial woes and the U.S. fight over the debt ceiling, risks to this already weak estimate abound.

Large cuts to government spending over coming months would present yet another hurdle.

(Reporting by Pedro Nicolaci da Costa; Editing by Andrew Hay)

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Comments (3)
TNelson wrote:
This is a very biased article. It presents Keynesian theory as if it is fact, but also only from one side. Gov’t spending MAY help in times of economic crisis, but only if you agree with Keynes.

However, it is hypocritical to defend government spending under the auspices of Keynesian fiscal theory, while also demanding tax hikes, which are also considered economically suppresive according to the theory.

Why doesn’t the author just come out and say it? He is liberal.

Jul 20, 2011 10:53am EDT  --  Report as abuse
TNelson wrote:
What do these same economists have to say about immediate tax hikes? This story seems a bit slanted toward the more-liberal solutions. Keynesian theory says that raising the tax level is bad for the economy too and Democrats support doing this more immediately than a balanced budget amendment would be enacted.

Jul 20, 2011 10:56am EDT  --  Report as abuse
TNelson wrote:
We do not know if government spending has been effective in boosting our economy. I was working on Capitol Hill when they passed the “stimulus,” it looked a whole lot like just another government budget. It seemed like the spending was not even being effectively tracked.

Are we just throwing money at a problem without making sure that it fuels free enterprise?

And again, why is spending better, when according to Fiscal theory (Keynesian economics), tax decreases have the same effect? How can one political party decry spending decreases while insisting on tax hikes? It all just feels too interested and partisan to me–as does this report.

Jul 20, 2011 11:03am EDT  --  Report as abuse
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