Yves Smith, at Naked Capitalism, has a post on the problems created by the current trend to argue for austerity measures to cure the deficit rather than government spending to stimulate the economy. Deficit Doves: The gift that keeps on giving, Naked Capitalism, June 27, 2010. Providing an excerpt from Warren Mosler (New Deal 2.0), who concludes that we ought to provide a government job to any able-bodied citizen who wants one to help transition back to a private economy that functions to create jobs, Yves reminds us of the way that mainstream economists (and the prestigious economic journals) favor tales of equilibrium in which austerity measures can bring a wayward budget back under control. Not really so, she says--the only way to overcome the kind of crisis we are in is through continued government spending.
[E]ven if the US had no trade deficit, the government would need to run a deficit to accommodate the desire of the private sector to save. The alternative would be that the US would need to go from its assumed trade balance to a trade surplus. That would happen through a fall in prices and wages in its tradeable goods sector (which can happen via domestic deflation, which will make debt burdens worse in real terms, or a fall in the dollar) and/or an increase in productivity so that our exports gained market share.
So, if we decide to run government surpluses now, the result is almost certain to be deflation, at best a Japan-type stagnation with high unemployment (and the US has far less social cohesion than Japan does), at worst a deflationary downspiral. But in either case, austerity becomes self-defeating. The value of outstanding debt rises as prices fall and GDP contracts. Default becomes more likely, and as defaults rise, banks become more impaired, investors more cautious, and the downturn can easily accelerate and become self-reinforcing.