economic policy

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Deficit Jumble

I missed this earlier, but here’s an interesting statement – part of an interview in early May given by John Boehner on Bloomberg TV:

“We have spent more than what we have brought into this government for 55 of the last 60 years. There’s no business in America that could survive like this. No household in America that could do this. And this government can’t do this.”

There are two crucial errors in this statement. Errors that indicate Boehner doesn’t understand, or chooses to misstate, the facts about debt.

First: it leaps off the page that if the US has managed to run Federal budget deficits for 55 of the past 60 years, and has managed to grow fairly consistently throughout, then those deficits weren’t much of a problem. How can they have been? Evidently that constant red ink did not impede us much, if at all.

Second: his knowledge of business is out of whack. There are plenty of businesses accumulating debt relentlessly. Adding to an existing pile of debt is not a predictor of doom the way Boehner wants us to believe. The crucial factor is whether that debt can be sustained. Can the business grow its income faster than its debt so that it can pay the interest?

So Boehner is flat out wrong.

There are many businesses in America that survive well even thought they pile up debt. And, yes, the government can do this too. Indeed, as history suggests, it isn’t difficult at all.

So Boehner’s objection to our current deficit cannot be based on this reference to history. Besides, Boehner voted repeatedly in support of budgets that oozed red ink during the Bush administration, so his sudden concern is a tad odd. We all know by now what his issue really is. He wants to slash social spending. Since to say this out loud is political suicide, he slides into an alternative: he complains about the debt in order to make it appear we cannot afford those social programs he hates so much.

But we can. We really can. As he inadvertently points out in the quote above.

It’s not just Boehner in this deficit jumble. The entire Republican party is as well.

Which makes for fun reading but gridlocked politics.

If only they’d say what they really mean. Perhaps then their jumble would go away.

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Shrinking Deficit

We have been bombarded for the past few years by an endless stream of analyses, diatribes, and invectives about the horrors associated with the Federal deficit. The tide of red ink that began to flood Washington at the end of the Bush administration and which has abated only slowly under Obama became a feature of the great political stand-off that has frozen policy making and disrupted Congress since 2009. In response to the yawning gap in the nation’s finances politicians, academics, the media, think tanks, and sundry hangers-on all felt the need to opine on the merits and demerits of a deficit that peaked at 10.1% of GDP back in the darkest days of 2009.

We have been treated to a variety of sober plans to slash it back in the name of preserving the nation, avoiding a burden on future generations, and restoring the full faith and credit of the government. Folks like Alan Simpson and Erskine Bowles have re-emerged from obscurity to become stars amongst the cognoscenti the membership of which was limited to those who saw the dangers of debt and advocated astringent urgent remedies.

We became used to being told that we could no longer afford the goodies we wanted. That Social Security needed “saving”. That Medicare was a looming disaster, and that in our newly diminished state we all had to tighten our belts, forgo nice things, and suffer the consequences of austerity. This was the new America, austere, harsh, but with balanced books. Our creditors would love us. Confidence would flow, and eventually the tide of red ink would be replaced by one of business, industry, and – perhaps – a recovery in employment.

Perhaps the most enduring images of this discussion were the various budget proposals put forward by Paul Ryan. He shot to fame from nowhere because his ideas were deemed a serious conservative alternative to the left’s older, and deemed tired, economics built largely on a Keynesian foundation. Since the right’s leading economic ideas were the root of the crisis, conservatives and self-styled centrists alike were desperate for a new hero who could be the anti-Keyenes. Ryan adroitly fit the bill. That his plans were a sham and didn’t even add up was never a concern. What mattered was that he advocated a solid dose of puritanical, morally uplifting, austerity designed to wean us all off of the government’s largesse.

So the deficit debate turned into one about the size and scope of government. The Republicans managed to exploit the gloom and angst over the rising debt by using it as a bargaining chip. They threatened to shut down the government. They threatened to renege on the national debt. They opposed all and every measure proposed to lift the economy, unless said measure was attached to the introduction of “vital” austerity. As a result, Washington lurched from one political crisis to the next. The economy languished. And we became stuck in a surrealistic stand-off with each and every offer advanced by Obama being rebuffed, even if it embodied austerity measures hated by his own supporters.

And then …

Something funny happened.

The deficit began to melt away. Not completely, but enough. Just like some of said it would. The vast drop in revenues and the equally vast jump in spending that happened because of the drop in economic activity in 2008 was cyclical. It was always going to go away if, and when, the economy came back to life. Which it has done. Just enough to make a big difference in the deficit.

Yesterday the Congressional Budget Office (CBO), the bipartisan referee of Washington facts and figures, published its revised budget outlook. It makes for startling reading.

The deficit is expected to shrink to a mere 2.1% of GDP by 2015. That’s below the 2.4% average for the forty years ending in 2008 before the crisis erupted. Not only that, but the deficit is now projected to be only 4.0% of GDP this year, weighing in at $642 billion. This means that the rapid upward tilt in the debt to GDP ratio that we had been warned would ruin us all is now set to sputter to a halt and even turn down a little. Instead of hurtling across the dreaded 90% cliff of doom – recall Reinhart and Rogoff’s infamous paper – the debt ratio will hover around 71% for the foreseeable future.

In short the panic is over. The deficit is under control. The debt ratio is high but just fine. We can relax.

We have no deficit problem.

This should make us all happy, right?

Well not really.

I think the deficit is too small. We have shrunk too fast too soon. We have drawn too  much demand from the economy before it was able to hum along without government help.

But that’s for another day.

The fun result of the CBO report is to watch all the austerity advocates scurry around to find new things to worry about, and new ways to justify inflicting pain on the poor, the sick, the young, and the less well off. After all, what’s a conservative to do if there’s no budget war to fight?

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The Deficit’s Too Small!

The entire conversation in and amongst our elite, whether be in Washington in big business or in the media, seems to be about the Federal deficit and the evils associated with it.

Here’s my current thinking:

The deficit is too small.

And it’s shrinking too quickly. The recovery, anemic though it is, is reducing the deficit. Tax revenues are rising as incomes and employment slowly recover. And spending is decreasing as emergency aid and benefits are less necessary. Our short to medium term deficit was, it turns out, largely cyclical not structural.

Now I realize that this is not the message you normally hear, so bear with me. My point is simply that government spending in the US is being reduced so rapidly that the private sector’s anemic expansion isn’t able to keep up sufficiently. This means that the economy is not growing as quickly as we need it to and, thus, this long and tortuous period of very slow recovery is being lengthened unnecessarily. We are shooting ourselves, very effectively and with great accuracy, in the foot.

We have not yet, fortunately, fallen too deeply into the trap that the Europeans have set for themselves and gone headlong into austerity driven economic suicide. The Germans appear to have decided to destroy the Eurozone by enforcing austerity despite the growing political backlash. They are trying to turn the entire continent into a mirror image of itself, which requires everyone to pretend that it was fiscal profligacy and not a banking system failure and private sector debt that caused the crisis. This misdiagnosis naturally leads to the wrong prescription. Hence the misguided focus on government budgets and not on encouraging growth.

We went through the mother of all recessions, indeed our banking system and private debt misbehavior was the progenitor of the entire mess, but we, at least, managed to get a little and short-lived stimulus. So we avoided the Euro trap. So far.

But the conversation remains stuck in a monotonous cycle of debate about how much to cut, what limits to set, and how much pain will be necessary for us to make the great magical leap forward.

The answer to these questions are: none, none, and none respectively. We keep treating our longer term issues – largely the cost of our terrible health care system – as if they are here and now.

Our problem is that the US elite cannot break out of its unneeded focus on austerity because to do so would be an admission of political and intellectual failure. There is too much committed to austerity for the correct policies to be discussed let alone enacted. So we live in a surreal world in which the entire discussion is about something totally irrelevant to our recovery.

We need more spending, not less.

We need to continue the deficit and increase it somewhat, not shrink it.

This is because the normal levers of policy – manipulating interest rates and printing money – cannot and will not work in our present situation. This leaves us with a looser fiscal policy as our one route out of malaise. But it is the one policy we are not talking about.

There is nothing new in any of the above, but I thought I would repeat it for the umpteenth time in the vague and forlorn hope it would resonate somewhere.

Anyway, since the austerity debate seems to be our fixation, let me point out that we have been squeezing the budget quite effectively – and wrongly – since 2010. That is if you look at the deficit as a ratio with respect to the total economy.

 

As you can see from this chart the cyclical reduction in spending has produced a rapidly reducing deficit. That upward slope is the sharpest tilt towards balance in the last forty years and is one of the primary reasons we are not seeing stronger growth. We have been overly austere. We are saving too much.

Why is this an important point?

Because none of the benefits of austerity have shown up. Not one. There has been no surge in confidence inspired supply side activity. And none of the downsides of easy money have shown up either: the much hyped and anticipated burst of inflation remains imagined but not real. In fact not one of the predictions made by the experts that litter our elite has turned out to be correct. Remember the Simpson-Bowles report? That was every serious person’s Rosetta stone of sensibility. Messrs Simpson and Bowles harangued us all about the evils of debt and loose money. They told us that disaster was a scant two years away if we didn’t enact drastic structural cuts to our budget – as opposed to the more cyclical reduction we have actually seen. That was over two years ago. Disaster hasn’t struck. The deficit has begun to shrink. Runaway inflation hasn’t shown up. Simpson and Bowles were flat out wrong. Meanwhile, practically every one of the predictions made by people like me who focus on aggregate demand as being our problem has been correct: the economy remains weak, low interest rates are having little effect, and unemployment is still a problem.

Which is why I feel confident in suggesting our present problem is that the deficit is too small.

That sharp upward slop in the chart above is a bad, not a good, thing.

Not that I expect anyone to listen.

 

 

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Seven Out Of Ten

Seven out of ten isn’t a bad score. It isn’t great either. It’s a majority, but isn’t totality.

What am I talking about?

I came across the reference to seven out of ten in Paul Krugman’s column this morning, and it’s worth pondering.

Let me set the scene:

One of the current most widely used criticisms of more stimulus for the economy – it could use the help – is that governments never get rid of the so-called ‘temporary’ measures once the emergency has passed. All that happens is that the programs designed to bolster the economy get baked into an ever growing pile of permanent government spending.This is not true. In fact it is way wide of the mark.

The best way to look at government spending is not in absolute dollars, but in the ratio of spending to GDP. With an ever growing population and an economy growing through time, the level of actual dollars spent is always going to rise. The crucial point is to see whether the portion of the economy designated as government spending is rising faster or slower than the whole.

And this is where seven in ten comes in.

Of the ten post World War II presidents before Obama seven have left office with government spending lower as a percentage of the economy than it was when they entered office. So we have only three fiscal laggards in the last seventy of so years. Three rotten apples who expanded government, and coincidentally, added to our national debt more than the others.

They were Ronald Reagan, and both the George Bush’s. Three rotten apples. Three Republicans. Three fiscal calamities.

This is not what you hear from right wingers of course.

Poor old Ronald Reagan, we are told, had to deal with those high interest rates. Remember those? Paul Volcker went after inflation by raising rates and plunging the economy into a severe recession in 1980/81. The downturn was  nasty. The recovery pretty good. And that explains Reagan’s pile of debt. Well not really. Reagan’s pile of debt came from his refusal to pay for his defense build up by raising taxes. Instead he borrowed the money. He thus earned his place in history as one of the few, very few, US presidents to expand the national debt during a period of non-emergency.

The key point to bear in mind about Reagan is that he might have been many things: he might have talked a good game, and he might well have been the originator of our current vogue of ‘blame the government’, but he was not, by any stretch of the imagination, a small government guy. No not at all. He expanded big government. Despite his rhetoric. And despite the efforts of his subsequent sycophants who toil endlessly to cover over the traces of his fiscal follies.

Then there was George I. No one seems to talk about him much any more. Probably for good reason. Go ahead: try to recall anything about him. Suffice to say he continued the Reagan trend, only with less brio.

And then we come to the true classic: George II. If ever anyone ought claim the title to fiscal recklessness George II is he.

Dear George II has left such a trail of wanton wreckage that we almost forget the horror that was his fiscal policy. He inherited a Federal budget under control and generating a small surplus, along with a government spending level on a downward track, and promptly blew it all up. The political headline was that if the Federal government budget is in surplus it must be taking in too much tax revenue. Therefore that surplus can be repaid to taxpayers without jeopardizing the government’s fiscal position. The political reality was different: the goal was not to balance the books by returning a modest amount. It was to undermine the government by returning so much that the books were thrown into imbalance and a false need to cut spending thus created. After all, if you want to get to a smaller government what better way is there other than to defund it?

The problem was that George II was not good at math and, besides, was not truly an advocate of small government. One or two of his pet projects, notably one to do with Medicare, piled on the government spending, but since he had cut taxes and thus revenue, debt  as a share of the economy rose, not fell, during George’s rein.

Naturally we are told by George II’s defenders – yes there are some – that his errors are really those he inherited from Clinton, and that the expansion of government during those long eight years was simply a function of Clintonian policies having a long incubation before they did their damage.

Sorry that won’t work. The Medicare Prescription Drug, Improvement, and Modernization Act of December 2003, which added about $530 billion to government spending, was not a Clinton era policy. It was the biggest revamp of Medicare since its inception, and included an infamous prohibition preventing the government from negotiating lower drug costs with the pharmaceutical industry.

So there you have it. The three rotten apples of fiscal imprudence all turn out to be Republicans. The clear message seems to be that if you want to expand government debt, elect Republicans. This is not exactly what you read about in the press is it?

Yes that’s right. The party currently venting its spleen over the need for tighter budgets and the dangers of debt is the very party that blazed the trail for increasing debt. It has, at least in terms of the post-war era, a long and hallowed tradition of inflating the debt, and fiscal recklessness.

Anyway, in case you think I am misleading you, here’s the chart:

 

 

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More Sideways Than Up

The economy just can’t get on a roll. We managed to get passed the slow down of late last year only to run full square into a self-inflicted slow down this year. Ugh. That’s a technical term for ‘I told you so’. The economy, as measured by Gross Domestic Product (GDP) grew at a 2.5% rate in the first quarter this year. The good news is that the economy gained speed – the last quarter of last year had seen anemic 0.4% growth. The bad news is that this acceleration is too slow to clear up all our excess capacity, especially our severe long term unemployment problem. It is also too slow to get us anywhere near back to our potential. Every day we slop about like this we leave wealth on the table unearned. And that matters to us all. Or at least it ought matter to us all. A lot.

Here’s the breakdown, as usual I show the contributions of each major part of the economy:

  • Personal Consumption grew at a 3.2% pace, contributing 2.24% to the total
  • Private Investment grew at a 12.3% pace, adding 1.56% to the total – of which 1.03% was in the form of inventory accumulation
  • Net exports reduced the total by 0.50% because the growth in exports was more than offset by growth in imports
  • Government spending continued to shrink and reduced the total by 0.80%

This is a really mixed bag.

As you can see, the biggest impetus to overall growth came from personal consumption, but no one expects this pace to carry forward much. Disposable incomes dropped 5.3% in the quarter due primarily to the rollback of the payroll tax holiday. Couple this with the continued decline in savings and it becomes very difficult to forecast strong personal consumption for the remainder of the year.

Then there’s the increasing negative effect of the decline in government spending. A large number of people, some in the media as well, seem not to realize that US government spending has been in decline for a while now. Right after the crisis hit, state and local governments around the country began to retrench in order to balance their books in the face of a collapse in revenues. The 2009 Federal stimulus meant that Federal level spending grew for a couple of years, but with that now fully worked through the system, and with the sequester cuts coming on line,  even Fed level spending is now declining. Add the two together and total governments spending is acting a strong brake on growth. Which is exactly not what we need to see. But Congress in its wisdom has decided to slash away at the economy. This is despite all the rapidly accumulating evidence that austerity doesn’t, can’t, and won’t work.

Let’s look at two charts:

Here’s GDP growth over the last few years …

Yes that dip was enormous.

Here’s how the total accumulation looks when we express it as a percentage the peak reached jut before the crisis …

As you can see we’ve managed to get back above the pre-crisis peak. But not by much. That’s because we are running well under a rate of growth enough to get us back to our potential. Here’s the gap between potential and actual …

 

And, last of all, here’s a look at the level of government spending as a percent of that potential GDP …

I think it correct to look at government spending in terms of potential, and not actual, GDP because the result gives us an idea of what that spending looks like were the economy in good shape and not impaired as it is now. Two points ought to leap out at you when you look at the last chart:

  1. Both the Reagan and Bush II years show sharper increases in government spending than the intervening Clinton years. Indeed if you look closely you can see that the Clinton era was one of good control over government spending.
  2. It is very clear that the leap in government spending associated with the crisis has not continued and that the Obama administration is overseeing the only non-recession caused contraction is such spending anywhere on the chart. In fact Obama is pursuing a tighter fiscal policy than any president of the past forty years.
  3. This Obama austerity movement is not something to applaud. Draining government spending from the economy before the private sector is back to full health makes matters worse, not better.

What does all this mean?

That the economy is not fully healed. That growth is more likely to slow than to accelerate. And that government fiscal policy is working in exactly the wrong direction.

This is not a good message. The first quarter’s 2.5% growth may well be the high water mark for the year. It’s most likely down hill from here.

Unless, of course, Congress decides not to be so stupid. That’s not happening though, is it?

 

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