Tyler Cowen, comme d’habitude, has some of the best thoughts on the downgrade. I especially think that the following observation is noteworthy:
I don’t expect anyone to change their mind at this point, but the “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view. Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times. We needed a big dose of inflation, promptly, right after the downturn. Repeat and rinse as necessary. But voters hate inflation and, collectively, we proved to be cowards. Too bad.
Concerning Professor Cowen’s observations regarding the need for revenue increases, I believe that those increases can be gotten through comprehensive tax reform that cuts the top rate by anywhere between ten and twelve points, while broadening the base, and getting rid of deductions. A VAT–the least distortionary tax there is, and one that is very good at collecting revenue–can also be added without harming the economy. Too bad that comprehensive tax reform is not in our future anytime soon; getting tax reform through Congress even during the best of times is a tremendously difficult proposition, and with an election year coming up and in the aftermath of a tremendously bitter fight over the debt ceiling, I just don’t see tax reform taking place in the near future.
Whether this downgrade turns out to have lasting effects remains to be seen; Moody’s and Fitch continue to give us a AAA rating. But at a minimum, this is highly embarrassing. Our prestige as a nation has taken a hit. I hope that the bond markets ultimately yawn; the Financial Times article I linked to above gives us reason to believe that it will, since, as Jack Ablin of Harris Private Bank points out, we have a savings glut, few safe havens, and the United States has one of the three most liquid sovereign bond markets. But we didn’t have to get to this position, it is a crying shame that we did, and the danger remains that the other two ratings agencies might follow suit.
Oh, and one more thing: There is enough blame to pass around for both parties when it comes to America’s fiscal situation. But many of the blogs on the port side are going to use this opportunity to try to blame Republicans for the ratings downgrade, rather than coming up with innovative ways to break the political impasse that–again–both parties have caused, and finding solutions to the ongoing debt crisis. Which tells you something about the proprietors of those blogs, I think.