Facts about the past or present are often hard to interpret. Facts about the future rarely exist, which leaves us with fantasies (forecasts) of pleasant anticipation or fearful apprehension.
The fiscal cliff is our best current example. The facts are if the Congress does not act by Jan. 1, federal tax rates will return to higher levels and federal expenditures will fall.
The apprehensive fantasy is a sudden rise in tax rates and a drop in spending will cause consumers and investors to cut back on their economic activities, leading to worse unemployment – the economy contracts.
The cheery fantasy sees investors and consumers so delighted with a more balanced federal budget, so relieved that the political impasse is over, that they go on a spending spree that not only overcomes the cutbacks, it exceeds them, stimulating a boom – the economy grows.
Which of these two scenarios is more likely?
If these were “normal” times, the more optimistic view might be tenable. It would work like this:
A more balanced federal budget (not even a surplus) would reduce the need for federal borrowing. This would reduce the role of the Treasury in the money market and decrease the demand for loanable funds. With loan demand down, interest rates would fall and private borrowers (consumers and investors) would respond positively to the lower rates. They would borrow more, spend what they borrow and stimulate economic growth.
However, increased private borrowing and spending would have to offset the federal reduction in spending and the increase in tax revenues. That requires an almost euphoric private sector. This might happen, if the fall in interest rates was a big one.
Can interest rates fall further? They now are so low that additional declines may be just a happy hallucination.
The more skeptical approach says raising taxes and cutting spending will reduce the deficit and ease pressure on the rising debt. Yet there is little benefit to this action, if we want to create more jobs. Instead we should be very selective in raising taxes and most careful about cutting spending.
If the private sector will not respond with gusto to lower interest rates, if those rates can not fall much further, then the answer to our economic woes continues to be low taxes and high spending by the federal government.
The fiscal cliff is right around the corner. No one wants to take that leap into the unknown.
The president offers a modest proposal raising taxes on only the top 2 percent of earners in this country. His spending cuts, like the proposals from the Republicans, are spaced into the future to have little impact on the immediate year ahead. Both sides are trying to do as little as possible now and leaving the big issues for later.
That may be the best policy. Sometimes wisdom demands putting off to tomorrow what you could do today.