Many have said that the questions raised undermine the claims of austerity advocates around the world that deficits should be quickly reduced. Some have gone so far as to blame RR for the unemployment of millions, asserting that they provided crucial intellectual ammunition for austerity policies. Others believe that even after re-analysis the data support the view that deficit and debt burden reduction is important in most of the industrialized world. Still others regard the controversy as calling into question the usefulness of statistical research on economic policy questions.

Where should these debates settle? From the perspective of someone who has done a fair amount of econometric research, consumed such research as a policymaker and participated as an advocate in debates about fiscal stimulus and austerity, here would be my takeaways.

First, the RR experience should accelerate the evolution of mores with respect to economic research. Rogoff and Reinhart are rightfully regarded as careful, honest scholars. Anyone close to the process of economic research will recognize that data errors like the ones they made are distressingly common.  Indeed the JP Morgan risk models in use when the London Whale trade was placed had errors not unlike those made by RR. In the future, authors and journals and commentators need to devote more effort to replicating significant results before broadcasting them widely. More generally, no important policy conclusion should ever be based solely on a single statistical result.  Policy judgments should be based on the accumulation of evidence from multiple studies done with differing methodological approaches. Even then, there should be a reluctance to accept conclusions from “models” without an intuitive understanding of what is driving them. It is right and understandable that scholars want their findings to inform the policy debate. But they have an obligation to discourage and on occasion contradict those who would oversimplify and exaggerate their conclusions.

Second, all participants in policy debates should retain a healthy skepticism about retrospective statistical analysis. Trillions of dollars have been lost and millions have been unemployed because the lesson was learned from 60 years of experience between 1945 and 2005 that “American house prices in aggregate always go up.” This was no data problem or misanalysis. It was a data regularity until it wasn’t. The extrapolation from past experience to future outlook is always deeply problematic and needs to be done with great care. In retrospect, it was folly to believe that with data on about 30 countries it was possible to estimate a threshold beyond which debt became dangerous. Even if such a threshold existed, why should it be the same in countries with and without their own currency, with very different financial systems, cultures, degrees of openness and growth experiences? And there is the chestnut that correlation does not establish causation and any tendency for high debt and low growth to go together reflects the debt accumulation that follows from slow growth.

Third, while RR’s work, even unqualified by the recent replication efforts, did not support the claims made by the prominent figures on the right in the U.S. and UK regarding the urgency of deficit reduction efforts, much of the joy taken on the left in their embarrassment is inappropriate. It is absurd to blame them for austerity policies. The authors of those policies chose the policies first and only then cast about for intellectual ballast. While there may be no threshold beyond which debt automatically becomes catastrophic, and while the British and American experiences are both suggesting that fiscal contraction in a slack economy where interest rates are near zero is inimical to growth, it is a grave mistake to suppose that the debt can or should be accumulated with abandon. On all but the most optimistic forecasts, further actions will be necessary almost everywhere in the industrial world to assure that debt levels are sustainable after economies recover. Now is not the time for austerity, but we forget at our peril that debt-financed spending is not an alternative to cutting other spending or raising taxes but only a way of deferring these painful acts.

PHOTO: A protester holds a placard during a rally in Trafalgar Square in central London May 1, 2013. REUTERS/Toby Melville

All this comes at a time of great challenge. Profound changes, as emerging economies led by China converge toward the West, will redefine the global order. Beyond the current economic downturn, which is surely the most serious since the Great Depression, lies the even more serious challenge of the rise of technologies that may well raise average productivity but displace large numbers of workers. Public debt is running up in a way that is without precedent except in times of all-out war. And a combination of the share of the population that is aged and the rising relative price of public services such as healthcare and education pressure future budgets.

Anyone who has worked in a political position in Washington has had ample experience with great frustration. Almost everyone involved with public policy feels as I do that there is much that is essential yet infeasible in the current political environment. Yet context is important. Concerns about gridlock are a near-constant in American political history and in important respects reflect desirable checks and balances; much more progress is occurring in key sectors than is usually acknowledged; and American decision making, for all its flaws, stands up well in global comparison.

It is a commonplace that the missing center makes political compromise impossible. Many yearn for a return to what they imagine as an earlier era when centrists in both parties had overlapping opinions and negotiated bipartisan compromises that moved the country forward. Yet fears about the functioning of our government like those expressed today have been recurring features of the political landscape since Patrick Henry’s 1791 assertion that the spirit of the revolution had been lost. It’s sobering to consider the degree of concern about paralysis that gripped Washington during the early 1960s when the prevailing diagnosis was that a lack of cohesive and responsible parties precluded the clear electoral verdicts necessary for decisive action. While there was a flurry of legislation passed in the 1964-66 period after a Democratic landslide, what followed were the cleavages associated with Vietnam and then Watergate, all leading to President Jimmy Carter’s famous declaration of a crisis of the national spirit. Whatever the view today, there was hardly high rapport in Washington during the term of Ronald Reagan. President Bill Clinton worked hard to establish rapport and compromise with a Congress controlled by the opposition only to be impeached by the House of Representatives after a bitter struggle.

Intense division and slow change have been the norms rather than the exceptions. While often frustrating, this has not always been a bad thing. Probably there were too few not too many checks and balances as the United States entered the Vietnam and Iraq wars. By my lights and that of many others, there should have been more checks and balances on the huge tax cuts of 1981, 2001 and 2003 or on unpaid-for entitlement expansions at any number of junctures. Most experts would agree that it is a good thing that politics thwarted the effort to establish a guaranteed annual income in the late 1960s and early 1970s or the effort to put in place what would today be called a single-payer healthcare system in the 1970s.

The great mistake of the gridlock theorists is to suppose that all progress comes from legislation and that more legislation consistently represents more progress. While these are seen as years of gridlock, consider what has happened in the past five years. The United States moved faster to contain a systemic financial crisis than any country facing such a crisis has moved in the last generation. Through all the fractiousness, enough change has taken place that without further policy action, the debt-gross domestic product ratio is expected to decline for the next five years. Beyond that the outlook depends largely on healthcare costs, but growth there has slowed to the rate of GDP growth for three years now, the first such slowdown in nearly half a century. At last, universal healthcare is in sight. Within a decade, it is likely that the United States will no longer be a net importer of fossil fuels. Financial regulation is not in a fully satisfactory place but has received its most substantial overhaul in 75 years. Most public schools and those who teach in them are for the first time evaluated on objective metrics of student performance. Gay marriage has become widely accepted across the states.

No remotely comparable list can be put forth for Japan or Western Europe. Yes, change comes rapidly to some of the authoritarian societies of Asia. But it may not endure and may not always be for the better. Anyone prone to pessimism would do well to ponder the alarm with which the United States viewed the Soviet Union after Sputnik or Japan in the early 1990s. It is the capacity for self-denying prophecy of doom that is one of America’s greatest strengths.

None of this is to say that we do not face huge challenges. The challenges, though, are less of getting to agreement where the answer is clear than of finding solutions to problems like rising inequality or global climate change, where the path is uncertain. That is not a problem of gridlock — it is a problem of vision.

There is a striking difference between financial crises in memory and as they actually play out. In memory, they are a concatenation of disasters. As they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the Korean crisis to the Russian default in 1998; six months from Bear Stearns’s demise to Lehman Brothers’ fall in 2008.

Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But the interpretation of improved market conditions is far from clear. Restrictions limit pessimistic investors’ ability to short European debt. Regulations enable local banks to treat government debt as risk-free, and they can fund it at the European Central Bank (ECB) on better-than-market terms. The suspicion exists that, if necessary, the ECB would come in strongly and bail out bondholders. Remissions sometimes are followed by cures and sometimes by relapses.

A worrisome recent indicator in much of Europe is the substantial tendency of stock and bond prices to move together. When sentiment improves in healthy countries, stock prices rise and bond prices fall as risk premiums decline and interest rates rise. In unhealthy economies, however, as in much of Europe today, bonds are seen as risk assets, so they are moving, like stocks, in response to changes in sentiment.

Perhaps it should not be surprising that Europe still looks to be in serious trouble. Growth has been dismal; the euro-zone gross domestic product has been below its 2007 level for six years, and little growth is forecast this year. For every Ireland, where there is a sense that a corner is being turned, there is a France, where questions increasingly arise about the political and economic sustainability of policy.

The controversy surrounding the decision by the European authorities to bail in Cypriot bank depositors suggests the degree of fragility in Europe. The idea that converting a small portion of deposits into equity claims in an economy with a population of barely more than 1 million could be a source of systemic risk suggests the hair-trigger character of the current situation.

Everything is compounded by political uncertainty. Italy’s last election was inconclusive even by Italian standards. Scandals and staggeringly high unemployment are taking their toll in Spain. France is much calmer about its situation than are many outside observers. And Germany’s primary concern is avoiding turmoil ahead of its fall elections. Given a choice, all would almost certainly prefer some kind of macroeconomic unorthodoxy to the breakdown of their monetary union. But there is a serious risk that as nations pursue their parochial concerns, the political and economic situation will deteriorate beyond repair.

Continued structural reform in the most troubled economies is essential, and the work of building a more satisfactory institutional foundation for the euro must go on. Critical to success will be (the belated) recognition of the paradox that in economic policy, as in so much of life, what is good for one is not good for all.

German policymakers constantly note that fiscal consolidation and structural reform were key to Germany’s rise from “sick man of Europe” to today’s position of strength. But Germany’s export growth and huge trade surplus were enabled by borrowing on the European periphery. If Europe’s debtor countries are to follow Germany’s historic adjustment path without economic implosion, there must be a strategy that assures increased external demand for what they produce. Simply put, there cannot be exports without imports. This could come from a German economy prepared to reduce its formidable trade surplus, from easier European monetary policies that spur growth and competitiveness, or from increased deployment of central funds such as those of the European Investment Bank or perhaps other sources. The crucial point is that no strategy for debt repayment can succeed without providing for an increase in the demand for the exports of debtor countries.

Invocation of necessity is not a strategy. As any student of Germany’s experience of the 1920s knows, it is far from a viable strategy to require a nation to service large debts by being austere when there is no growth in demand for its exports.

European policymakers, the International Monetary Fund and others with a stake in Europe’s outcome need to recognize that the history of financial crisis is a history of windows of opportunity missed. New business is always more exciting than unfinished business. And where matters are controversial, forced moves are easier for policymakers because they can be portrayed as moves of necessity rather than choice. So outsiders avoid confrontation and insiders embrace drift. The consequences could be grave.

PHOTO: A police officer walks in front of a bus station where an anti-bailout banner is placed outside the parliament in Nicosia March 18, 2013. REUTERS/Yorgos Karahalis

The U.S. economy grew at a rate of 1.5 percent in 2012. Last week, the independent Congressional Budget Office projected that growth will be only 1.4 percent during 2013 – and that unemployment will rise. While the CBO says that growth will accelerate in 2014 and beyond, it nonetheless predicts that unemployment will remain above 7 percent until 2016.

A weak economy and limited job creation make growth in middle-class incomes all but impossible, add pressure to budgets by restricting tax revenue and threaten essential private and public investments in education and innovation. Worse, they undermine the American example at a dangerous time in the world.

We can do better. With strains from the financial crisis receding and huge investment possible in energy, housing and reshored manufacturing, the United States faces a moment of opportunity unlike any in a long time. The economy could soon enter a virtuous cycle of confidence, growth and deficit reduction, much like it did in the 1990s. But this will require moving the national economic debate beyond its near-total preoccupation with federal budget restraint.

Yes, fiscal restraint is necessary in the medium term to contain financial risks. But unlike in the 1990s, when reduced deficits stimulated investment by bringing down capital costs, fiscal restraint cannot be relied on to provide stimulus now when long-term Treasurys yield less than 2 percent.

A broader growth-centered agenda is needed to propel the economy to its “escape velocity.”

First, as the president has recognized, the budget cuts implicit in the sequester scheduled to begin in March should not be reduced but spread over time. The economy is already taking a significant hit from increases in payroll taxes. Sudden across-the-board slashing of military and civilian spending will hurt the economy and seriously damage military readiness.

Second, the president and Congress should fix a firm year-end deadline to address the international aspects of corporate tax reform. We are in the worst of all worlds: U.S. companies have nearly $2 trillion in cash sitting abroad because of tax burdens on bringing it home and the perception that relief may be on the way. Ideally, the international tax system should be reformed in a way that is revenue-neutral but increases the attractiveness of bringing foreign profits home. This would be accomplished by replacing the current high rate of tax levied only on repatriated profits with a much lower tax levied on all global profits. If such reform is not going to happen, this should be clarified so business does not keep planning for an amnesty that will not come.

Third, no American, regardless of his or her ideology, should be satisfied with the way the nation’s housing finance system is working. After a period when cheap mortgages were too available, the pendulum has swung too far; a lack of finance is holding the economy back. The clearest evidence is the growing number of lower- and middle-income families paying rents to the private-equity firms that own their homes at rates far above what a mortgage would cost.

Fannie Mae and Freddie Mac, the government-sponsored housing enterprises, have historically provided support to the mortgage market in difficult times. It is high time they be forced to step up and support would-be lenders. Ultimately government support for owner-occupied housing should be curtailed, but now is not the time.

Fourth, the transformation of the North American energy sector needs to be accelerated. This will have economic and environmental benefits. Those who will decide whether to approve the Keystone XL pipeline, which would run between the tar sands of western Canada and Nebraska, need to recognize that Canadian oil not flowing to the United States will probably flow to Asia, where it will be burned with fewer environmental protections.

Natural gas exploitation, too, could bring huge environmental benefits. Replacing coal with natural gas has much more scope to reduce greenhouse gas emissions than more fashionable efforts to promote renewables. A period of record-low capital costs and high unemployment is the best possible time to accelerate the replacement cycle for environmentally untenable coal-fired power plants. More generally, the production of natural gas and its use in industry should be a substantial job creator for years to come.

More could be added to this list, including innovations in regulation and finance with respect to infrastructure investment. Unlike deficit reduction, in which all the choices are painful, measures to spur growth can benefit all Americans as well as help the federal budget. Growth and job creation are, after all, ultimate ends of economic policy. They as much or more than fiscal issues should become the focus of our national economic conversation.

While economic forecasts are uncertain, the great likelihood is that debts will rise relative to incomes in an unsustainable way over the next 15 years without further actions beyond those undertaken in the 2011 budget deal and the end of year agreement that averted a fall over the “fiscal cliff.” So even without the risk of self-inflicted catastrophes — like the possible failure to meet debt obligations or the shutting down of government — it is entirely appropriate for policy to focus on reducing prospective deficits.

Those who argue against a further concentration on prospective deficits on the grounds that – contingent on a forecast that assumes no recessions – the debt to gross domestic product ratio may stabilize for a decade counsel irresponsibly. Given all uncertainties and current debt levels, we should be planning to reduce debt ratios if the next decade goes well economically.

Reducing prospective deficits should be a priority – but not an obsession that takes over economic policy. This would risk the enactment of measures such as pseudo-temporary tax cuts that produce cosmetic improvements in deficits at the cost of extra uncertainty and long-run fiscal burdens. It could preclude high-return investment in areas such as infrastructure, preventive medicine and tax enforcement that would, in the very long term, improve our fiscal position.

Economists have long been familiar with the concept of “repressed inflation.”  When concern with measured inflation takes over economic policy and drives the introduction of price controls or subsidies to hold down prices, the results are perverse.  Measured prices may not rise and so the appearance of inflation is avoided.  But shortages, black markets, and enlarged budget deficits appear. The repression is unsustainable. When it is relaxed, measured inflation explodes, as in the case of the Nixon price controls in the early ’70s.

Just as repressing inflation is misguided, so also repressing budget deficits can be a serious mistake.  As with corporate managements judged only on a single year’s earnings take perverse steps that are ultimately harmful to shareholders, government officials in the grip of a budget obsession repress rather than resolve deficit issues.  When arbitrary cuts are imposed, government agencies respond by deferring maintenance leading to greater liabilities later.  Or compensation is provided in the form of promised retirement benefits that are less than fully accounted for, with the ultimate burden on taxpayers increased.  Or measures like the recent Roth IRA legislation are enacted, encouraging taxpayers to accelerate their tax payment while reducing their present value.

As important as avoiding the repression of budget deficits is insuring that focus on the budget deficit does not come at the expense of other equally real deficits.  Interest rates in the United States and much of the industrialized world are remarkably low right now. Indeed in real terms the government’s cost of borrowing has recently been negative for horizons as long as 20 years.  No one who travels from the United States abroad can doubt that we have an enormous infrastructure deficit.  Surely even leaving aside any possible stimulus benefits, current economic conditions make this the ideal time for renewing the nation’s infrastructure. Given a near-zero real rate, such investments need not increase debt-to-GDP ratios if their contribution to economic growth raises tax collections.

Infrastructure deficits are only the most salient of the deficits the United States faces. We clearly are living nearly six years after the onset of financial crisis with substantial jobs and growth deficits.  Consider this: An increase of just .15 percent in the growth rate maintained over the next 10 years would reduce the debt-to-GDP ratio in 2023 by about 2.5 percentage points, an amount equal to the much debated end of year tax compromise. Increasing growth also creates jobs and raises incomes.

By all means let’s address the budget deficit. But let’s not obsess over it in ways that are counterproductive, and let’s not lose sight of the jobs and growth deficits that will ultimately have the greatest impact on how this generation of Americans lives and what it bequeaths to the next one.

So far, the debate has focused on scaling back provisions of the tax code that have favored activities traditionally deemed to be valuable. For example, there is talk of reducing deductions for charitable contributions, taxes paid to state and local governments, home mortgages, employer-provided health insurance and many less important provisions.

There are reasonable arguments to be made in each case. But taking only the “limit tax incentives” approach to tax reform has several major defects. First, if reform is designed to avoid perverse outcomes — such as the crushing of charitable contributions or more pressure on state budgets — then it will raise limited amounts of revenue. Second, this approach will address very little of the complexity in the code and is not likely to do much for recovery, since it will do little to increase demand. Third, it will do little to address concerns about fairness: The richest taxpayers actually make relatively little use of deductions and credits.

What is needed is an additional element, one that has largely been absent to date: the numerous exclusions from the definition of adjusted gross income that enable the accumulation of great wealth with the payment of few or no taxes. The issue of the special capital gains treatment of carried interest – performance fee income for investment managers – is only the tip of a very large iceberg. There are far too many provisions that favor a small minority of very fortunate taxpayers. Because these provisions effectively permit the accumulation of wealth to go substantially underreported on income and estate tax returns, they force the federal government to consider excessive increases in tax rates if it is to reach any given revenue target.

All parties — whether their primary concern is preserving incentives for small businesses, closing prospective budget deficits or protecting the social safety net — should be able to come together around the idea that it should not be possible to accumulate and transfer large fortunes while avoiding taxation almost entirely.  Yet this is all too possible today.

Here are some issues the Obama administration and Democrats and Republicans in the U.S. Congress should consider in light of the magnitude of prospective deficits and the extraordinary good fortune of those at the top of the income distribution.

Why do current valuation practices built into the tax code make it possible for investment partners to end up with $50 million or more in entirely tax-free individual retirement accounts when the vast majority of Americans are constrained by a $5,000 annual contribution limit?

A simple calculation shows that our estate tax system is broken. Assets that are passed to relatives or other personal relations are often badly misvalued relative to what they cost on an open market. The total wealth of American households is estimated at more than $60 trillion.  It is heavily concentrated in very few hands. A conservative estimate given the lifespans of Americans would be that 2 percent ($1.2 trillion) is passed down each year, mostly from the very rich. Yet estate and gift taxes raise less than $12 billion, or just 1 percent of this figure each year.

If a family’s home rises in value by more than a $500,000 exclusion over the course of its dwelling, then it pays capital gains tax on the difference between the value now and the value at purchase.  But real estate investment operators, who sell properties whose value is measured in the hundreds of millions if not the billions of dollars, are able to take tax deductions for “depreciation” on their properties. And they are then able to sell these properties at an appreciated price while avoiding capital gains tax through what is known as a “like kind exchange” but which is in fact a sale.

Why should international companies be able to locate the lion’s share of their foreign income in small, low-tax jurisdictions such as Bermuda, the Netherlands and Ireland, and avoid paying taxes?

There are sound arguments for a preferential rate on capital gains. But is there any real justification for allowing those who do not need to sell their assets to finance retirement to avoid capital gains taxes entirely by including them in their estates?

These examples of tax rules that permit the taxes of the wealthiest  Americans to be far less than commensurate with their good fortune have the virtue of being relatively comprehensible. There are many others involving issues such as derivative accounting, pooled interests and leveraged leases that are neither easily explainable nor easily justified.

The failure to tax capital gains at the point of death costs the federal government about $50 billion a year. Taxing those gains would both raise money in the future, and induce earlier and greater realizations of capital gains in the short term, likely adding well over $500 billion over a 10-year period. I believe it is plausible to raise $1 trillion over the next 10 years by going after such provisions that cause what adds to wealth and spending not to be regarded as income.

It has been observed that the greatest scandals are not the illegal things that people do but the things that are fully legal. This is surely true with respect to a tax code in urgent need of reform.

PHOTO: A 2011 U.S. Individual Income Tax Return form is seen in New York April 17, 2012. REUTERS/Shannon Stapleton

First, Boskin is correct in noting that current budget deficits and rates of debt accumulation cannot be maintained indefinitely, and that stabilizing and ultimately reducing the debt-to-GDP ratio is important if all sorts of economic horrors are to be avoided. This is a point of agreement between the two candidates–not a basis for choosing between them.

Second, Boskin blames the current high level of deficits on President Obama’s policies, but that is hard to square with the facts. When President Clinton left office in 2001, we were paying down the national debt at the rate of several hundred billions of dollars a year with budget surpluses. Since that time the Bush administration moved the United States substantially into budget deficits with large tax cuts, major military commitments to wars in Iraq and Afghanistan and a new prescription drug entitlement ‑ all undertaken without offsetting expenditure reduction or increasing revenue. Beyond these decisions, the largest factor in the current level of deficits is the worst economic downturn since the Depression ‑ a downturn that began under President Bush. People will debate the merits of President Obama’s stimulus measures ‑ though I think their positive effect on growth and employment is quite clear ‑ but this debate matters little. Government employment has been contracting, and the debate over stimulus has largely faded.

Third, Boskin blurs the facts on who has been constructive with respect to deficit reduction. In addressing the Simpson-Bowles plan, he neglects to mention that the plan was dead on arrival when presented in November 2010 because of the implacable opposition of House Republicans, led by Paul Ryan who voted against the plan within the commission. It has long been clear that President Obama is prepared to reach an agreement based on the underlying principles of Simpson-Bowles. But that has not been possible because Congress is unwilling to raise revenues in addition to cutting expenditures. Governor Romney seems to share this resistance, having vowed that he would not accept even $1 of revenue increases for every $10 of expenditure cuts.

Fourth, in asserting that Governor Romney has a plan to balance the budget, Boskin is blithe, to say the least. Relative to current law, Romney has committed to a 20 percent tax rate reduction that independent observers calculate as costing $5 trillion over 10 years; defense spending increases in the $2 trillion range; and preservation of President Bush’s tax cut for the top 1 percent of taxpayers that costs $1 trillion. He has said nothing about how this is to be financed other than referencing loopholes for high-income taxpayers. Unfortunately, as independent analysts have repeatedly pointed out, there are not nearly enough loopholes. Even if he closed all tax credits and deductions for high-income taxpayers, he could not offset the cost of his high-income tax cuts, let alone the cost of his entire program. And this is before any consideration of the cost of balancing the budget.

Only the election can stop this kind of back-and-forth argument. This campaign has offered a superb contrast of the economic approach of President Obama and Governor Romney. Obama is carrying on the approach pursued by President Clinton. Romney would go back to the tactics of both Presidents Bush. The results of the two approaches in terms of economic growth, job creation, government debt and virtually every other economic statistic speak for themselves.

PHOTO: U.S. President Barack Obama speaks at a campaign event at Fifth Third Arena at the University of Cincinnati, November 4, 2012. REUTERS/Larry Downing

Even as our politicians disagree on a great deal, most experts can agree on the objectives of economic policy. The next president will not have succeeded in the economic area unless he accomplishes three things:

1. Reestablishing economic growth at a rate that makes real reductions in unemployment possible.
2. Placing the nation’s finances on a stable foundation by putting in place measures to assure that U.S. sovereign debt is declining relative to America’s wealth.
3. Renewing the economy’s foundation in a way that can support steady growth in middle-class incomes over the next generation, along with work for all who want it.

Where are the candidates on these three issues? President Obama has recognized that the inadequacy of demand is the principal barrier to growth and has sought to bolster both public- and private-sector demand since becoming president. Recent work by the IMF has confirmed the premise of his policies: namely, that at a time when short-term interest rates are at zero, fiscal policies are especially potent. The president has also respected the independence of the Federal Reserve as it has sought to respond creatively to the challenge of increasing demand even with short-term interest rates zeroed out. And he has put the economy on track to nearly doubling exports over five years through a series of measures, such as increasing government support for exporters. He has made clear his commitment to taking advantage of current low interest rates to finance public investment and protect public-sector jobs, and to continue to promote US exports.

In contrast, Governor Romney supports immediate efforts to sharply reduce government spending even as economic slack remains and Congress—at the president’s behest—has already legislated the most draconian domestic discretionary spending cuts in history. Through some set of intellectual gymnastics, Mitt Romney concludes that a government purchasing a new weapon systems or the recipient of a tax cut buying luxury goods creates jobs, but spending on fixing schools and highways does not. He also seems comfortable involving himself in monetary policy, favoring a reduction in the supply of credit relative to current Fed policy. And his insistence that he will name China a currency manipulator on his first day as president, even before his appointees have moved into their offices, surely increases uncertainty by making a trade war possible.

President Obama has embraced the principles, though not all the details, of the famous Simpson-Bowles commission report on budget deficits. Like the large group of CEOs who made a major statement on deficit reduction last week, he insists that achieving sustainable finance means both containing spending (especially on entitlements) and raising revenue. The budget that he has put forward has been thoroughly audited by the Congressional Budget Office, and puts the U.S. debt-GDP ratio on a declining path within this decade. And he has made clear that in negotiations with willing partners, he is prepared to go beyond his current budget proposals to assure that debt is contained.

Governor Romney, in contrast, has not suggested even a partial approach to the budget that has enough detail for independent experts to fully evaluate. He has however insisted on the need for over a trillion dollars more military spending than was recommended by George Bush’s defense secretary, Robert Gates, and for 20 percent across-the-board tax cuts that independent estimates suggest would cost close to $5 trillion over the next decade. To offset these measures that have no counterparts in the president’s proposals, he has spoken of “closing loopholes” without naming any specific items. And he’s done so in the face of repeated demonstrations that even the elimination of every tax benefit for those with income over $200 thousand would raise far less than the totality of his proposals would cost.

From the Lewis and Clark expedition to the land-grant colleges to the transcontinental railroad to the interstate highway system to the original research and development that led to the Internet, the federal government—with leadership from both political parties—has always sought to lay a foundation for future prosperity. President Obama has continued this tradition, recognizing that in an uncertain world some investments will work out better than others.

While audits have found many fewer problems with public investments than most expected over the last few years, much has been accomplished. Major efforts to measure and act on student achievement results are now in place in most states. Medical records are being systematically computerized. Domestic fossil fuels and renewable energy sources are meeting more and more of our energy needs. New financial protections are in place for consumers even as the capital reserves required of financial institutions have been substantially increased and student lending has been streamlined. These steps illustrate the kinds of progress that a second Obama administration would strive towards.

Governor Romney has made clear a preference for using any available resource to reduce tax rates below their current level—in the hope that there are great investments that firms are not making, even in the face of sub-2 percent interest rates and the lowest effective tax rates in generations. If this represents a foundation for prosperity, it will be very different than the one America has enjoyed historically.

PHOTO: U.S. President Barack Obama holds up a padlock alongside Master Lock’s Senior Vice President Bob Rice as Obama tours the factory in Milwaukee, Wisconsin February 15, 2012. Obama toured the business to highlight his ‘blueprint for an economy built to last’.    REUTERS/Jason Reed 

The U.S. still peers over a fiscal cliff, Europe staggers forward preventing crises King Canute-style with fingers in the dyke but no compelling growth strategy, and Japan remains stagnant and content if it can grow at all. Meanwhile, each BRIC is an unhappy story in its own way, with financial imbalances impeding growth in the short run and deep problems of corruption and demography casting doubt on long-run prospects.

In much of the industrial world, what started as a financial problem is becoming a deep structural problem. If growth in the United States and Europe had been maintained at its average rate from 1990 to 2007, GDP would be between 10 and 15 percent higher today and more than 15 percent higher by 2015 on realistic projections. Of course this calculation may be misleading because global GDP in 2007 was inflated by the same factors that created financial bubbles.  Yet even if GDP was artificially inflated by 5 percentage points in 2007, output is still about $1 trillion short of what could have been expected in the U.S. and EU.  This works out to more than $12,000 for the average family.

With these results, it will be argued that the process of international economic cooperation is failing. It will be suggested that there have been failures of leadership on the part of the major actors. There will be calls for changes in the international economic architecture.

There is some validity in all of this. Political constraints interfere with necessary actions in much of the world because international processes do not trump domestic imperatives. U.S. politics have been dysfunctional in the run-up to the 2012 election.  The European Union sometimes makes the U.S. Congress look like a model of crisp efficiency in coming to conclusions. In Russia and China, authoritarian leaders lacking legitimacy have difficulty driving economic reform. So also do those with democratic mandates in India and Brazil.

Concern about dysfunctional politics and the processes of international cooperation is certainly warranted. But the best one can hope for from politics in any country is that it will drive rational responses to serious problems. If there is no consensus on the causes of or solutions to serious problems, it is unreasonable to ask a political system to implement forceful actions in a sustained way.  Unfortunately, this is to an important extent the case with respect to current economic difficulties, especially in the industrial world.

While there is agreement on the need for more growth and job creation in the short run and on containing the accumulation of debt in the long run, there are deep differences of opinion both within and across countries as to how this can best be accomplished.

What might be labeled the “orthodox view” attributes much of our current difficulty to excess borrowing by the public and private sectors; emphasizes the need for credibly containing debt accumulation over the long term; puts a premium on austere fiscal and monetary policies; and stresses the need for long-term structural measures rather than short-term, demand-oriented steps to promote growth.

The alternative “demand support view,” while recognizing the need to contain debt accumulation and avoid high inflation, emphasizes the need for steps to increase demand in the short run as a means of jump-starting economic growth and setting off a virtuous circle in which income growth, job creation and financial strengthening are mutually reinforcing.

International economic dialogue has been defined by vacillation between these two viewpoints over the last few years.  At moments of particularly acute concern about growth like spring 2009 and the present moment, the IMF and many but not all monetary and fiscal authorities tend to emphasize demand-support views. But as soon as clouds start to lift, orthodoxy reasserts itself and attention shifts to fiscal contraction and long run financial hygiene.

This is a dangerous cycle whatever your economic beliefs.  Doctors who prescribe antibiotics warn their patients that they must complete the full course even if they feel much better quickly.  Otherwise they risk a recurrence of illness and worse yet the development of more antibiotic resistance. So too with economic policy.  Advocates of orthodoxy prize consistency. Those like me whose economic thinking emphasizes promoting demand, worry that expansionary policies carried out for too short a time prove insufficient to kick-start growth while at the same time discrediting their own efficacy and reducing confidence.

The Tokyo meetings may not have had an immediate impact. But the IMF’s recognition of the need to sustain demand and avoid lurches to austerity can be very important for the medium term if and only if it is sustained through the next round of economic fluctuations.

PHOTO: International Monetary Fund (IMF) Managing Director Christine Lagarde speaks at the Development Committee at the IMF and World Bank Annual Meetings in Tokyo October 13, 2012. REUTERS/Stephen Jaffe/IMF/Handout

Unfortunately for the British economy, nothing in the record of the last several years compels me to revise my views. British economic growth post-crisis has lagged substantially behind U.S. growth, and the gap is growing. British GDP has not yet returned to its pre-crisis level and is more than 10 percent below what would have been predicted on the basis of the pre-crisis trend. The cumulative output loss from this British downturn in its first five years exceeds even that experienced during the Depression of the 1930s. And forecasts continue to be revised downward, with a decade or more of Japan-style stagnation now emerging as a real possibility on the current course.

Whenever policy is failing to achieve its objectives, as in Britain today with respect to economic growth, there is a debate as to whether the right response is doubling down – perseverance and intensification of the existing path – or recognition of error or changed circumstances and a change in course. In Britain today such a debate rages with respect to the aggressive fiscal consolidation that the government has made the centerpiece of its economic strategy.  Until and unless there is a substantial reversal of course with respect to near-term fiscal consolidation, Britain’s short- and long-run economic performance is likely to deteriorate.

An effective policy approach to Britain’s economic problems must start with the recognition that the principal factor holding back the British economy over both the short- and medium-term is the lack of demand. It is certainly true that Britain faces important structural issues, ranging from difficulties in promoting innovation to deficiencies in the system of worker training. But it is apparent from the relatively low level of vacancies, the reluctance of workers to leave jobs, the pervasiveness across industries and occupations of increased unemployment and the testimony of firms regarding the formation of their investment plans that it is lack of demand that is holding the economy back from producing as much as it could.

Keynes writing during the Depression compared Britain’s economic problems to a “magneto” problem, referring to the fact that a car might have many infirmities, but if its electrical system did not work, the car would not go, and if it were fixed, the car would go even with other problems. So it is today. Moreover, to an extent that is greatly underappreciated in the policy debate, short-run increases in demand and output would have medium- to long-term benefits as the economy reaps the benefits of what economists call hysteresis effects. A stronger economy means more capital investment and fewer cutbacks to corporate R&D; it means fewer people lose their connection to good jobs and get addicted to living without work; it means that more young people get first jobs that put them on ladders to success; and it means more businesses choose leaders oriented to expansion rather than cost-cutting. The most important structural program for raising Britain’s potential output in the future is raising its actual output today.

The objection to this view comes in many forms, but it is in essence that “reversing course on fiscal expansion now would undermine credibility, backfire with respect to growth by risking a spike in capital costs, and risk catastrophe down the road as debts became unsustainable.” This line of argument is profoundly flawed. First, the behavior of financial markets suggests that it is economic weakness rather than profligacy that is the main source of concern about credit problems down the road. Why else would the tendency be for the costs of buying credit insurance on the UK to rise overall as interest rates fall? In similar vein, a strong tendency has emerged in both the UK and U.S. for interest rates to rise and fall together with stock prices, implying that it is evolving optimism and pessimism about the future, not changing views about fiscal policy, driving market fluctuations. Second, the reality is that the primary determinant of fiscal health in both the U.S. and UK over the medium term will be the rate of growth the economy achieves. An extra percentage point of growth maintained for five years would reduce Britain’s debt-to-GDP ratio by close to 10 percentage points, whereas austerity policies that slowed growth could even backfire in the narrow sense of raising debt-to-GDP ratios and turning the unsustainability of debt into a self-fulfilling prophecy.

A change in the pace of fiscal consolidation is necessary for Britain to have a chance to avoid a lost decade of economic performance. It is, to be sure, not sufficient. Rather than starving public investment today, now is the time to add to confidence by making plans for structural reforms to contain the growth of public consumption spending over time. It is also time to take overdue measures to promote exports and, after years of appropriately low investment, to restart housing investment. But at a time when demand is needed for growth and the private sector is hanging back, the first priority must be for the public sector to stop exacerbating the contraction.

PHOTO: Britain’s Prime Minister David Cameron gestures while viewing a parade of British Olympic and Paralympic athletes through London September 10, 2012. REUTERS/Adrian Dennis/POOL