When viewing the US fiscal stand-off from Europe, it all looks eerily familiar. The US has become very European. But for me the main problem is not an inability to deal with the structural deficit, as the Economist argued in its latest cover story, but rather the contrary. I fear that the US is blindly rushing into semi-automated austerity, which is exactly the mistake we have made in Europe. The problem is not the size of the national debt as such, which is manageable in both cases, but our policies in dealing with it.
The various measures in last week’s US budget deal imply revenue increases in the order of about 2 per cent of gross domestic product. This is the absolute size of the agreed measures. It does not include any further spending cuts that may, or may not, come as part of an agreement on a debt ceiling. The gross fiscal contraction of the US will be larger than the UK’s in 2013, though not as large as that in Spain, Portugal or Greece. Still, this would make the US an honorary member of Europe’s austerity club.
If there has been an overriding lesson from the eurozone crisis, then it must be that the fiscal multipliers – the effect of austerity on growth – become very high when monetary policy has reached the zero bound, and when everyone pursues austerity at the same time. The International Monetary Fund started a debate on the multiplier last year, culminating in a recent paper by Olivier Blanchard and Daniel Leigh, explaining why economic forecasts have been so persistently wrong during the crisis. Just how large the multiplier will be this year is difficult to say exactly and may vary across countries, but it is certainly higher now than before the crisis.