Spend or cut spending? That's the central question

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If historians 500 years hence read the text of political speeches and the more “cerebral” blogs and news magazines, it would seem to them that an epic battle of ideas is under way among economists. This interpretation would be a mistake. The simple truth is that economic debates are far more sanguine, with more universal agreement than is apparent to outsiders. Let me explain.

For a long time, perhaps two centuries, economists have largely agreed on a simple set of issues, such as that markets produce the best outcomes for society in terms of economic growth and opportunity. Likewise, we generally agree that less regulation is better than more regulation, and regulation should exist only in a few instances where those markets fail to deliver. These “market failures” are rare but important. They occur in instances where third parties are injured due to an exchange between two others (as with pollution), where no market for a service could exists (such as with the need for a police department), where obtaining information about goods is difficult (as with financial services) or where a firm colludes to obtain a monopoly.

To be sure economists disagree about the particular of instances of each of these, but these arguments are not mostly about the big matters. Rather it is the details, or nuance of the actual circumstances, or the size of the problem that animate arguments. The central issues are largely settled in a way that infuriates many people who wish the world were less complex than it is in reality.

The big ideas I have mentioned thus far are what economists call microeconomics. The term microeconomics has a huge definition, but it is really everything economists do that is not related to the ups and downs of the business cycle. We call that macroeconomics and here there is a great (and vituperous) disagreement on the right task for government in stabilizing a recession.

Nearly all economists believe that, all else being equal, an increase in government spending or a temporary tax cut will cause demand for goods and services to increase in the short run. Clearly, this would be convenient in a recession. However, these same economists also believe that a large government debt will also reduce investment and hiring, which is bad. Oh, and by “believe,” I mean these economists have authored or subscribed to research that concludes these conditions to be true.

The problem is that these two truths exude tension. A correctly sized stimulus might improve the economy in the short run, while the ensuing debt might dampen long-run growth. So, what to do? Spend or cut spending? Over the past decade, governments have spent like never before, so it is hardly too soon to wonder if the spending and concomitant debt hasn't outdone the stimulus. That alone is the great policy debate of our time. It is useful to observe that those places with solid fiscal discipline – Indiana and Germany among them – have done very well. The others have not.