The S&P Credit Downgrade

Published on: 14:26PM Aug 13, 2011


"the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011"
One of the main reasons that the ‘multiplier’ effects of the stimulus have not taken hold, and the reason that the economy is recovering so sluggishly is the uncertainty in the regulatory environment. Last fall, NCBA president Steve Fogelsong put this quite well in an interview on Agritalk where he discusses the regulatory zeal including cap and trade, the takeover of the financial and auto industry, the student loan industry, dust regulation, inheritance taxes, failure of pending free trade agreements, as well as livestock marketing regulations to name a few (at 9:23 on the clip you can find here
A very similar argument  is also well put in a post on the economics blog Café Hayek:
"But if the decline in GDP growth and in the rate of employment are caused, not by a taste-driven increase in the demand for money but, instead, by a large enough disruption in what Arnold Kling calls "patterns of sustainable specialization and trade," then kicking up aggregate demand won't solve the problem. Neither kicking it up, or trying to, through monetary policy or through fiscal policy will work. The problem is not originally one of widespread inadequate demand…. it is clearly the result of distorting government policies, regulatory and monetary, leading up to 2008 as well as of the symptom-treating policies since then that only worsen matters. (And not to mention yet other actual and threatened policies)"
The issue of regulatory uncertainty is not unique to our current economic challenges, we had a very similar situation following the Great Depression, which lasted for over a decade. According to Robert Higgs, this was largely the result of New Deal Policies that created regulatory uncertainty prolonging the depression. You can find his paper here. You can also find a good discussion of this work on the EconTalk podcast here.
I’ve shared a lot of the following research in the past discussing the prediction that the stimulus probably would not work, but given the recent downgrade in the U.S. credit rating, it seems like it is worth a review:
"The Keynesians had it all wrong. In the Great Depression, employment was not low because investment was low. Employment and investment were low because labor market institutions and industrial policies changed in a way that lowered normal employment." --Edward C. Prescott Federal Reserve Bank of Minneapolis Quarterly Review Winter 1999, vol. 23, no. 1, pp. 25–31
"We find that New Deal cartelization policies are an important factor in accounting for the failure of the economy to recover back to trend." -Journal of Political Economy, 2004, vol. 112, no. 4 New Deal Policies and the Persistance of the Great Depression : A General Equilibrium Analysis. Harold L. Cole and Lee E. Ohanion.
"We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income." ---The Great Depression in the United States From A Neoclassical Perspective Federal Reserve Bank of Minneapolis Quarterly Review Winter 1999, vol. 23, no. 1, pp. 2–24
"Businessmen came to ask themseleves whether Roosevelt really understood a system where the hope of profit sparks expansion and investment. Or did he believe simply in centralizing decision and authority in boards and "planners" along the Patomac?" ---The Enterprising Americans: A Business History of the United States BY JOHN CHAMBERLAIN INSTITUTE FOR CHRISTIAN ECONOMICS TYLER, TEXAS 
Until we can start thinking outside the box of Keynesian economic policies as well as get a handle on the uncertain regulatory environment, we won’t likely see a strong recovery. That means higher budget deficits and downward pressure on future credit ratings.
For a more entertaining look at policy alternatives, I highly recommend the following youtube videos:
Fight of the Century