Further contributing to the new Democratic line are two factors. First, interest rates are going to rise sharply in coming months as businesses borrow for expansion, prices begin rising from low recessionary levels, and the rate of return to capital goes up. The Federal Reserve may also be forced to raise short-term rates--something liberals will strongly encourage in order to slow the economy and make deficits more politically potent. This strategy was signaled in the New York Times' lead editorial on Nov. 9.
Second, Howard Dean's decision to forego matching funds probably means that whomever gets the Democratic presidential nomination will do the same thing. This means that the Democratic candidate will have to expand his fundraising base beyond Hollywood and labor unions. He must appeal to Wall Street and the business community in order to raise enough campaign money. Deficit reduction will be attractive to this audience.
If this plan is successful, it could lead Republicans into the trap of doing some kind of major deficit reduction before the election. But to be meaningful, such a package would have to include tax increases and cuts in Medicare, especially if defense is off the table. This will open the door for Democrats to scare seniors and demoralize the Republican base, as George H.W. Bush's 1990 budget deal did, which lead to the election of Bill Clinton in 1992.
Republicans need to be aware of what is happening and prepare themselves to respond to the deficit argument. Unfortunately, they cannot make the case that they have tried to limit the size of government, but were stymied by Democrats. First, they haven't even attempted to limit spending. Second, Republican control of Congress gives them no excuse.
Ironically, one ally Republicans may find is Bill's Clinton's top economist, George Stiglitz. In his new book, The Roaring Nineties (Norton), he throws cold water on the idea that the 1993 budget deal brought interest rates down and sparked economic growth. "Interest rates would have fallen anyway," he writes. And growth was mainly due to technological innovation, increased international competition, reduced inflation and other factors unrelated to the budget.
I think President Bush is smart enough not to fall into the trap Democrats are setting. As long as growth remains solid and jobs continue to increase, he will likely win reelection. But after the election, deficit reduction will become a high White House priority.