NCSU economist: Markets push politicians to act

Posted August 7, 2011 2:48 p.m. EDT
Updated August 7, 2011 11:30 p.m. EDT

— Any long-term improvement in the U.S. economy will require painful choices, the kinds of choices that politicians have been thus far unwilling to make, according to Mike Walden, an economist and professor at North Carolina State University.

Walden pointed to recent drops in the stock market and Standard & Poor's downgrade of the federal credit rating as examples of how financial markets and institutions will press for those unpopular moves. 

"There will be monetary consequences for continuing to delay these hard decisions," Walden wrote in answer to questions from WRAL News Sunday. "

There is no question that the federal government faces a long-run fiscal issue. This issue was already evident prior to the recession. The recession simply sped the trend."

Walden returned to the familiar theme of the rising cost of government benefits promised to an aging population as a point of contention. His best-case solution for country involves both changes to the tax code and to the benefits.

Walden cited the commission headed by Erskine Bowles, former UNC System and Bill Clinton chief of staff, and former Republican Sen. Alan Simpson, as a template for a balanced way to tackle the debt crisis. The Bowles-Simpson plan called for raising taxes by $1 trillion and doing away with popular tax write-offs like the one homeowners use to deduct mortgage interest. It also recommended cuts to Medicare and Social Security.

Walden said limits on some tax deductions and credits while lowering tax rates could encourage investment. Walden also advocating raising the age of eligibility for some government programs and considering limiting payouts to high-income households.

The biggest immediate threat to consumers from the credit downgrade would be an increase in interest rates, driving up the cost of borrowing for everything from retail credit to home mortgages. Walden pointed out that in other countries a similar move yielded little change in interest rates.

If consumers are cowed, however, the sputtering economy could stall, Walden said. 

"the driving force in the economy is still consumer spending, and if the downgrade results in a weaker stock market and higher interest rates, then these reactions would work against the already-modest economic recovery," he said.

Walden said he did not want to predict what stocks might do when the markets open on Monday. 

"The downgrade had been expected, so it may already be priced into the stock market," he said. "On the other hand, many were surprised the downgrade came so quickly."