On Twitter/X, Bob Elliott has been sharing his observations about American consumer behavior. Elliott, a seasoned investor and businessman, points out a paradoxical economic scenario: despite low mortgage rates and increased household wealth, both consumers and businesses are exhibiting remarkable restraint in borrowing and spending.
Elliott noted:
“So far the expansion hasn’t required increased household borrowing to continue, but with rates falling we are now likely to start to see some pent up demand (particularly for houses) start to emerge. Mortgage rates have fallen to their lowest levels in years.”
He further explained:
“Part of the reason why households can be confident about taking on new borrowing is that those with assets have much greater wealth than they did relative to nominal incomes back in the 2000 period. And up considerably from pre-COVID levels.”
Elliott’s analysis leads to an important question: Why aren’t American consumers and businesses taking advantage of these favorable conditions to borrow more?
His insights got me thinking about the Expansionary Fiscal Contraction (EFC) theory, a powerful economic concept that shaped policy thinking during my time as an economist at the Danish Ministry of Economic Affairs in the late 1990s. The theory suggests that fiscal austerity—cutting government spending and reducing deficits—can stimulate economic growth under certain conditions, and this idea was central to Danish policy-making for decades. It contributed significantly to Denmark’s fiscal discipline and economic resilience.
The Danish Model: Fiscal Discipline Drives Growth
Denmark’s experience in the early 1980s serves as a textbook example of EFC in action. Faced with economic challenges like high inflation, unemployment, and public debt, the Danish government implemented a stringent fiscal consolidation program. Under the Schlüter government, Denmark cut government spending, raised taxes, and pegged the krone to the Deutsche Mark to stabilize inflation.
The results were remarkable. Inflation fell, interest rates dropped significantly, and private sector investment surged. Denmark’s current account balance shifted from a deficit into a surplus. While unemployment took some time to respond, it began to steadily decline, leading to sustained economic growth. This period is a prime example of how fiscal responsibility can lead to economic expansion.
The US Scenario: Fiscal Uncertainty Hampering Growth
In contrast, Elliott’s observations about the US economy reveal a different picture. Despite mortgage rates falling significantly, housing demand remains relatively weak. Household wealth has increased substantially in recent years, but this hasn’t translated into higher consumer spending or borrowing, as might typically be expected.
The root cause of this cautious behavior appears to be public debt. With US public debt growing rapidly and continuous deficit spending, uncertainty has been cast over the economy. Rational economic actors, anticipating future tax increases or inflation to address this debt, are understandably holding back. This is a textbook case of Ricardian equivalence, where expansionary fiscal policy is offset by private sector restraint due to fears of future fiscal tightening.
The Case for Immediate Fiscal Consolidation
The solution to this dilemma is straightforward: the US must embark on a path of fiscal consolidation immediately. This isn’t just about balancing the books; it’s about restoring confidence in the economy’s long-term stability. The government must implement substantial spending cuts and reform entitlement programs to ensure their sustainability.
Additionally, the tax code should be simplified to encourage work, saving, and investment. A clear, legislated path for deficit reduction with enforceable targets should be established, ensuring that future fiscal policies maintain discipline.
These measures will undoubtedly face political resistance. However, as Denmark’s experience shows, short-term pain leads to long-term gain. By demonstrating a genuine commitment to fiscal responsibility, the government can restore confidence in the economy’s future.
The Benefits of Fiscal Consolidation
Critics may argue that fiscal tightening will lead to a recession, but the EFC theory, supported by evidence from countries like Denmark, suggests otherwise. When implemented decisively, fiscal consolidation can lead to lower interest rates, which in turn stimulates private investment and boosts confidence in the economic outlook.
In Denmark, fiscal consolidation not only stabilized the economy but also increased international competitiveness, as resources shifted from the public sector to the more efficient private sector. This created a stronger foundation for export growth and economic resilience.
Restoring Confidence in the US Economy
Bob Elliott’s analysis suggests that there is untapped potential for growth in the US economy. Households have significant wealth, and businesses are financially strong. What’s missing is the confidence that the fiscal environment will remain stable in the long term. A credible commitment to fiscal consolidation would address this uncertainty and likely spur the private sector to borrow, invest, and spend more—unlocking the pent-up demand that Elliott identifies, especially in the housing market.
As I speculated in my own tweet, the US may be experiencing a “Ricardian” episode, where consumers and businesses are holding back due to fears of future tax hikes. This suggests that fiscal consolidation could be the key to restoring private sector confidence, just as it was in Denmark in the early 1980s.
Conclusion: Embrace Fiscal Responsibility
The path forward for the US is clear. To unlock the potential for growth that Bob Elliott’s analysis suggests is waiting in the wings, the government must embrace fiscal responsibility. This means making tough choices now to secure a prosperous future.
By learning from Denmark’s successful implementation of EFC principles, the US can create an environment of fiscal stability that encourages private sector activity. Only through a genuine commitment to sustainable public finances can we unleash the full productive potential of the American economy.
The time for half-measures and political compromises is over. The US needs a bold, unapologetic commitment to fiscal discipline. This is not just sound economics; it’s the only responsible course of action for a nation that aspires to long-term prosperity and economic leadership.
