Duncan and Coyne on “The Overlooked Costs of the Permanent War Economy”

I hope my loyal readers will forgive me for going a bit overboard on the fact that I think cuts in US defense spending will do the US economy well, but you have to read Thomas K. Duncan and Christopher J. Coyne’s new paper on “The Overlooked Costs of the Permanent War Economy”. Here is the abstract:

How does the permanent war economy interact, and subsume, the private, non-military economy? Can the two remain at a distance while sharing resource pools? This paper argues that they cannot. Once the U.S. embarked upon the path of permanent war, starting with World War II, the result was a permanent war economy. The permanent war economy continuously draws resources into the military sector at the expense of the private economy, even in times of peace. We explore the overlooked costs of this process. The permanent war economy does not just transfer resources from the private economy, but also distorts and undermines the market process which is ultimately responsible for improvements in standards of living.

Just have a look at this excellent paper and then I will shut up about this issue – for now at least.

Cato Institute on US military spending and the fiscal cliff

In an earlier post I claimed that the “full” fiscal cliff would not necessarily be a disaster for the US economy – and I was probably also unusual forthcoming in my hope that US defending might be cut as a result of the fiscal cliff, but this blog is primarily about monetary policy issues so I don’t want to bore my readers with more of my views on the US defense budget. Instead I would like to recommend my readers to have a look at what the Cato Institute has to say on this issue.

This is from Cato Institute’s Facebook page:

In recent days several senior Republicans have come out saying they would be willing to break their anti-tax pledge as part of the fiscal cliff negotiations. At least one of those lawmakers, Senator Lindsey Graham, has said that this is because he is unwilling to let sequester budget cuts “destroy the United States military.” Cato scholars have long argued that the proposed sequester cuts would allow the United States to maintain a wide margin of military superiority, while paying substantial dividends for the U.S. economy over the long run.

• “Budget Hawks or Military Hawks?,” Cato Video with Grover Norquist – http://youtu.be/C7AWXLDPmE0

• “The Bottom Line on Sequestration,” by Christopher Preble –http://www.cato.org/publications/commentary/bottom-line-sequestration

• “The Pentagon Will Survive the Fiscal Cliff,” by Justin Logan –http://www.cato.org/publications/commentary/pentagon-will-survive-fiscal-cliff

Enjoy and stop worrying about lower public expenditures – after all the Sumner Critique applies: NGDP will be unaffected by lower defense spending as long as the Federal Reserve implements the Bernanke-Evans rule. By the way fiscal conservatives should be impressed with this – if the Fed keeps NGDP on track (or follow a Bernanke-Evans style policy rule) then it will remove any keynesian style opposition to fiscal consolidation.

You might also want to have a look at this excellent article by Gallaway and Vedder on the “The Great Depression of 1946”. There was of course no Great Depression in 1946 despite a massive cut in US military spending by the end of the Second World War. It is not everything Gallaway and Vedder write that I agree on, but I nonetheless think that they make a very compelling case that even drastic cuts in defense spending is unlikely to lead to any serious economic downturn. That was the case in 1946 and would be the case in 2013.

By the way Cliff is not worried…

Cliff-Clavin-Forget-the-Fiscal-Cliff-CNBC

The fiscal cliff is good news

When I started this blog I set out to write about monetary policy issues – primarily from a none-US perspective – and furthermore I am on vacation with my family in Malaysia so writing this blog post goes against everything I should do – however, after listen to five minutes of debate about the ”fiscal cliff” on CNBC tonight I simply have to write this: What is your problem? Why are you so scared about fiscal consolidation? After all this is what the fiscal cliff is – a 4-5% improvement of public finances as share of GDP.

The point is that the US government is running clearly excessive public deficits and the public debt has grown far too large so isn’t fiscal tightening exactly what you need? I think it is and the fiscal cliff ensures that. Yes, I agree tax hikes are unfortunate from a supply side perspective, but cool down a bit – it is going to have only a marginally negative impact on the long-term US growth perspective that the Bush tax cuts expiries. But more importantly the fiscal cliff would mean cuts in US defense spending. The US is spending more on military hardware than any other country in the world. It seems to me that US policy makers have not realized that the Cold War is over. You don’t need to spend 5% of GDP on bombs. In fact I believe that if the entire 4-5% fiscal consolidation were done, as cuts to US defense spending the world would probably be a better place. But that is not my choice – and it is the peace-loving libertarian rather than the economist speaking (here is a humorous take on the sad story of war). What I am saying is that the world is not coming to an end if the US defense budget is cut marginally. Paradoxically US conservatives this time around are against budget consolidation. Sad – but true.

Since September the Federal Reserve has had the Bernanke-Evans rule in place. That means basically means that the Fed will step up monetary easing in response to any increase in unemployment. Hence, if the full fiscal cliff leads to any increase in unemployment the fed will counteract that with monetary easing. So effectively the fiscal cliff means fiscal tightening and monetary easing. This of course would also be the case if the fed was a strict inflation targeting central bank – that directly follows from the Sumner critique.

Fiscal consolidation and monetary easing is this is exactly what the US had in 1990s – the best period for the US economy since WWII. By at that time a Democrat President also had to work with a Republican dominated Congress.

So no, I don’t understand what there is to fear. Lower public spending and easier monetary policy is the right medine for the US economy (yes and please throw in some structural reforms as well). If that is the fiscal cliff please bring it on. It will be good for America and good for the world. And it might even be a more peaceful world.

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PS if you are really concerned about the fiscal cliff just agree on this:

1) Cut US defense spending to 2% of GDP

2) NO tax hikes

3) Commit the fed to bring back NGDP to the pre-crisis trend level through QE

Update: My version (second and third!) version of this post had an incredible amount of typos – sorry for that. I have now cleaned it up a bit.

Update 2: David Glasner also comments on the fiscal issue – David agrees with me in theory, but is more worried about the what the fed will do in the real world. When David is saying something I always listen. David is a real voice of reason – often also of moderation. That said, I strongly believe the Sumner Critique is correct. NGDP is determined by monetary policy and not by fiscal policy – so if the fiscal cliff will lead to a recession the fed will be to blame and not the US politicians (they are to blame for a lot of other things…).

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