Recession’s Fatal Error

Debt and taxes: “Over the next four years, the ratio of U.S. government debt will rise to somewhere between 71% and 80% of GDP, up from 41% at the end of 2008. The 71% figure”, which is from the CBO, and likely understated.

The most extensive research on tax multipliers is found in a paper written at the University of California Berkeley titled ‘The Macroeconomic Effects of Tax Changes’: “Estimates Based on a new Measure of Fiscal Shocks, by Christina D. and David H. Romer (March 2007). This study found that the tax multiplier is 3, meaning that each (1) dollar rise in taxes will reduce private spending by $3.” By the way, Christina Romer now chairs the president's Council of Economic Advisors.

“Presently, the federal government is increasing spending that in the end may actually retard economic activity, and is also proposing tax increases that will further restrain private sector growth. This policy mix is the same approach that failed in the U.S. from 1929 to 1941 and also failed in Japan over the past two decades.” In other words, fiscal policy is executing a program that is contrary from what it should be to stimulate the economy.

Financial Advisor Peter Hargreaves says “that talk of 'green shoots' gives rise to illusions. People think they see the light of dawn when the sun is still going down”. This recession becoming more and more a severe economic depression won’t have V–shaped recovery. Not even a W-shaped double decline. "There could be a quadruple (WW-shape) dip in my opinion," he said.

And what about California? “This week's The Economist magazine gives a new measure for California' budget deficit, now $26 billion, up from the $24 billion last reported. California is the world's 8th largest economy. It cannot print money but IOUs when it runs out of money. But there's no law that says banks have to take them.” Actually the banks stopped taking them last week leaving California in big trouble.
 
The problem is as with much of the rest of this world, politicians have promised too much, without being willing to raise the money to pay for all that was promised. The solution: Spend less. Or tax more. Or do both.

However in a democracy is no accountability, in order to get elected politicians has to promise more and more 'benefits.' There is no backing up or turning around, even when the government is clearly heading into bankruptcy, as is the case nowadays. If a politician hesitates, some other one will just take his place. He will not go on record to tell people: "Look, we'd like to continue these programs; but we don't have the money."
Politicians surely are capable of making rational decisions. But what is rational for them – ducking serious issues or nourishing the illusion that voters can get something for nothing. And that is exactly the fatal error.