Why Republicans Ran Deficits

There is a lot misunderstanding of why policymakers refused to cut government spending or tighten monetary policy during the early 2000s–despite Republican majorities in Congress and a Republican president.  Partly this was the Bushites’ idea that Republicans could copy Democrats and buy off voters with a Republican New Deal (i.e. Medicare Part D and other spending), which Republican voters like myself so rightly resented.  But other factors were at play as well.

In 1997, much of Asia suffered a debilitating financial crisis.  In the years that followed, their governments made a conscious decision to self-insure against future crises by building up foreign exchange reserves, which they did by suppressing domestic demand and manipulating their currencies to engineer large trade surpluses.

This presented a problem to U.S. policy makers: Foreign nations were manipulating their currencies in an attempt to force exports into the United States. U.S. policymakers believed they not only had to accept this, they had to encourage it–or else the U.S. would fall into a deep recession.  Anything that might lessen the growth of imports–cuts in government spending, higher Fed interest rates, tighter mortgage regulation–would spark that recession (why they believed this is story unto itself, but they did).

They were mistaken, and badly so.  By encouraging imports and the trade deficit to grow, they ultimately created the 2008 financial meltdown.  But even more importantly, there were policy options that would have let the U.S. cut it’s budget deficit and raise interest rates without a recession.  They were virtually unknown at time, but they did exist.  In essence, the government could have offset the interventions foreign governments were making in our economy with tax policy.  Foreign governments were artificially lowering labor costs by manipulating their currencies and suppressing demand–that’s how they created such large trade surpluses–and if we had lowered labor costs ourselves–say, by cutting employer payroll taxes or the corporate tax rate–we would not have had to dance to their tune.

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