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Obama or Romney: Whose debt reduction plan does history favor?

The two presidential candidates would pursue different paths to lead the US out of debt. Here's how debt-saddled countries of yore have dealt – successfully and unsuccessfully – with the problem, and how those lessons might apply today.

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Lesson No. 2: Austerity or stimulus – a tricky choice

Some economists affiliated with the Romney campaign have argued that "fiscal consolidation" – essentially cutting spending to reduce deficits and the overall size of government – can help promote economic recovery.

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But last year, when Italian economist Roberto Perotti looked for historical evidence, he found that four leading examples – countries that had combined austerity and recovery – didn't demonstrate clearly that spending cuts would spur growth in the US today.

Finland was a case in point. In the early '90s it suffered the worst recession of any advanced nation, and by the end of 1992 it "was widely considered the basket case of Europe," Mr. Perotti writes in his study, published late last year. The nation's economic output had fallen 14 percent, and government debt was soaring.

To get its house in order, the government pursued a mix that included tax hikes as well as spending cuts, Perotti found. The economy recovered, though slowly. The public debt was stabilized. But Perotti concludes that this success story hinged on an export boom and on declining interest rates.

Today, the US already has ultralow interest rates and would find it hard to follow the Finnish model on trade, which included a major currency devaluation. Such a move is difficult, since other nations want to keep their own currencies weak to promote exports.

What about the opposite approach: stimulus? Most economists embraced the idea of a large stimulus package in 2009, as the nation reeled in recession. Even today, the government could pump more money into the economy through various spending efforts and tax cuts.

Some prominent economists back this approach, noting that US economic output is still running about 4 percent below its potential.

"It's not that complicated," argues Jared Bernstein, a former Obama administration economic adviser. "When the private sector is still climbing off the mat, [there's a] role for government to temporarily fill the gap."

But the lessons of history on stimulus aren't clear-cut, either. On the positive side, an assessment released this month by International Monetary Fund (IMF) economists concluded that the "multiplier" benefits of stimulus programs appear to be larger than usual since the 2008 recession, given "today's environment of substantial economic slack."

The IMF also warns that if too many nations tighten their fiscal belts all at once, it would damage global growth.

"Everyone agrees that imposing fiscal austerity in a very short period of time depresses the economy and makes it even harder to grow out of the debt problem," says Ed Yardeni, an economist who runs an investment advisory firm in Great Neck, N.Y.

At the same time, he and others point to Japan as an example of a nation that has tried fiscal stimulus in recent years without generating strong growth. Its national debt has soared to world-leading proportions, raising the risk of a financial crisis there.

What Lesson No. 2 means now

Obama and Romney aren't campaigning overtly as apostles of either stimulus or austerity. But the goal of shrinking government is one of five core planks in Romney's economic plan. Obama, by contrast, has proposed an American Jobs Act that blends temporary tax cuts with spending on things like preventing teacher layoffs and building roads. Judging by such evidence, Romney leans more toward austerity and Obama more toward stimulus.

In practice, however, it appears US fiscal policy is headed in the austerity direction, whoever occupies the White House.

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