The Deficit Choice: What The White House Is Thinking

Huge deficits will be omnipresent throughout President Obama's first term, complicating his administration's messaging efforts on the economy. But advisers separate the political repercussions from the actual underlying fiscal and monetary policies.  In some ways, the short-term politics of the deficit are negligible. They're preferable to the short-term politics of a much higher unemployment rate with no economic growth -- and a smaller deficit.

What's more important, to the administration, at least, is the degree to which the deficit has an impact on market expectations and the behavior of market players. If the goal is to stimulate private sector job growth, how the market feels about deficits -- and to the degree that the deficits reduce the incentives for investment -- this is the site of the most important political interaction. More government spending, in the form of, say, a bailout of state and local governments or a second federal stimulus -- may not have enough support in Congress, but the private sector is where the White House believes that growth needs to come from -- the government has already provided a trillion dollars worth of stimulus.  Having abandoned the concept of moral hazard to save the economy in 2009, the administration will use it to their advantage in 2010.

The White House believes that when Americans say they're worried about the deficit, they're motivated by a search for clues that the current administration is budgeting responsibly.  The White House time horizon, remember, is focused on sustainable growth over the long-term. The employment picture is terrible, but the continuing government transfer payments -- extensions of COBRA and unemployment insurance -- are militating the social effects off mass unemployment.

Conservatives are going to run on deficits and spending because they can, and because those issues serve as proxies for a range of objections to the size and scope of government. The Obama administration is going to focus on slowly changing the fundamentals. There will be talk of real, across-the-board limits to discretionary spending.  There will probably be a bipartisan deficit reduction panel set up, along with, perhaps, another Social Security reform commission. 

The Obama White House won't bailout state governments. Aside from small, precise interventions, like an extension of the homeowners' tax credit, business tax relief, and continual UI and COBRA extensions, the White House won't 'do" much of anything to kickstart the economy in 2010.

At some point next year, the unemployment rate will start to come down. The deficit will remain high, but the administration is confident that a good vector for the rate along with visible economic growth will enhance consumer confidence and induce more spending. If consumers are spending -- if they sense that their personal incomes are rising --- they will be less amenable to Republican economic arguments. 

Indeed, some GOP strategists are already counseling their clients not to shoot their wad on the economy, anticipating that it will recover enough.