Some claim that House budget proposal H.R. 1 to reduce the growth of federal government spending will cause a slowdown in the economy and even increase unemployment. Consider, for example, a recent report by Alec Phillips of Goldman Sachs which claims that the House proposal would reduce economic growth in the second and third quarters of this year by 1.5 to 2 percent if enacted into law next month. Nothing could be more contrary to basic economics, experience and facts. Unfortunately, the report has been widely cited by those wanting to hold back on this first step to restore sound fiscal policy. And the Washington Post reports this morning that Mark Zandi of Moody’s is starting to make similar claims, which should be questioned for the same reasons.
There are several things wrong with the analysis used in Goldman Sachs report. First, it does not take account of the beneficial effects of starting now on a credible plan to reduce the deficit. Basic economic models in which incentives and expectations of future policy matter show that a credible plan to reduce gradually the deficit will increase economic growth and reduce unemployment by removing uncertainty and lowering the chances of large tax increases in the future. The high unemployment we are experiencing now is due to low private investment rather than low government spending. By reducing some uncertainty and the threats of exploding debt, the House spending proposal will encourage private investment.
