Last week we talked about the first stage of the U.S. fiscal crisis: the slow erosion of long-term growth because of mounting government debt. This phenomenon arises from a straightforward application of conventional supply-side economics. Government borrowing absorbs private saving that would otherwise be used for capital formation. The diminished capital stock reduces productivity, growth, and competitiveness.
This week we look at stage two: a rapid economic meltdown precipitated by an untamable accumulation of government debt. Stage two is much more difficult to understand than stage one. Government debt in distress is not something that gets much attention from economists who study developed countries. It’s not something they were taught when they went to economics school. So as the possibility of a crisis has become more real, they are trying out a lot of new ideas.
One nice thing about this otherwise gloomy state of affairs is that politics has not yet infected the economics. The research that you see is not by economists who are pushing a partisan agenda, but by people who are genuinely concerned that the economy may be running itself off a cliff.