July 12, 2011 12:22 pm

Time is of the essence, any US budget deal will do

With the US economy as weak as it is, any agreement must be pushed forward as soon as possible, writes Larry Summers

As the debt negotiators square off in Congress, much attention will focus on the size of the 10-year budget deal they come up with. As almost everyone agrees, there is much more risk of doing too little than too much given the scale of America’s fiscal challenge.

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The truth is that the expected impact of the deal over a 10-year period will not be its most important aspect except in the context of the current media cycle. Very little hinges on whether the deal picks up the low-hanging fruit with respect to entitlements and revenues – or even breaks some new ground – this year or in the next couple of years.

Agreements reached now are subject to revision, potentially radical revision following next year’s election. Businesses are basing their investment decisions on the size of their current order books, not their guesses of fiscal policy in 2015. Consumers are deciding whether or not to spend based on how confident they are that they can hold on to their jobs.

Here is what is not getting its due attention. Decisions about spending and taxing over the next year or two will have a significant impact on job creation over the next year, the economy over the next decade and on the path of US national debt over an even longer horizon.

Suppose any proposed deal could be adjusted, thereby adding an extra 1 per cent to gross domestic product growth over the next year. A reasonable assumption is that the increase in output might not be sustained as inflation slows down, investment is increased, fewer workers abandon the search for jobs, and so forth.

Assume the impact falls from 1 per cent to 0 per cent over the course of a decade. The consequence would be an increment to GDP of 0.5 per cent or about $1,000bn over the period. That would represent close to 4m job years. And it would reduce deficits by about $400bn – more than it looks like Democrats will be able to come up with in revenue raising or Republicans in cuts to the cost of healthcare.

Is there scope for adding fiscal measures that would contribute 1 per cent of GDP or more over the next year and a half? Absolutely. With economic demand constrained and in a liquidity trap where interest rates cannot fall further, fiscal policies have larger than normal effects. With even very conservative estimates of multiplier effects, a combination of continuing payroll tax cuts, maintaining support for unemployed workers, and accelerating infrastructure maintenance could add closer to 2 per cent of GDP growth over the next year and a half.

Usually the media and Washington take too short a view. Now is the rare time when all need to remember that you only get to the long run through the short run. Given the current weakness of the US economy what is most important is that any budget deal be pushed forward as soon as possible.

The writer is Charles W. Eliot university professor and president emeritus at Harvard University. He was Treasury secretary under President Bill Clinton

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