CHICAGO--()--In the October issue of Themes on the Economy®, Chief Economist Diane Swonk tackles common myths about the economy. Buying into an easy answer for a complex question can lead to “conclusions that are misleading at best and would be outright disastrous at their worst.” Tinkering with a cutting-edge economic model as a student at the University of Michigan, she learned that the simplest solution to reducing the budget deficit – eliminating one big category like the defense department – could create numerous, unintended reactions. “The results were devastating: employment plummeted, unemployment soared, incomes declined, spending contracted, investment imploded and the economy was driven into a deep recession. The federal deficit narrowed, but only temporarily.” Then entitlements soared as a result of the sharp, economic contraction.
“Congress would still have to find another $750 billion… to put the deficit on a more sustainable path.”
It’s the same story if one believes that tax increases or spending cuts alone could solve our deficit problems. Spending cuts? 25% cuts across the board in entitlements could do that. Try cutting Medicare or Social Security for current recipients, a generation that votes religiously. Tax increases? Even if all the Bush and Obama-era tax cuts were repealed, with the exception of the alternative minimum tax, “Congress would still have to find another $750 billion… to put the deficit on a more sustainable path.”
Another myth: Increases in the Federal Reserve’s balance sheet equal government spending. Actually, they “represent an investment in an asset rather than spending on a specific project or program, such as building roads and bridges. Quantitative easing (buying assets to expand the Fed’s balance sheet) has so far “generated substantial profits (almost $200 billion); those profits have been returned to the Treasury and helped to reduce, rather than increase, the federal budget deficit.”
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