Network News

X My Profile
View More Activity

Lower deficits aren't always better deficits

GR2010041204614.gifDavid Cho's story that the deficit is running significantly lower than it did last year has provoked a fair bit of controversy. On the one hand, the Office of Management and Budget doesn't like to see midyear numbers floating around, even if they'll be happy to see these numbers keep up. "While the positive news is welcome, it is premature and irresponsible to be making deficit projections for the fiscal year as a whole," said OMB spokesperson Ken Baer. On the other hand, some economists see this as actual bad news. "Unemployment is higher than it was a year ago," wrote Brad DeLong, "and so the deficit ought to be higher: a lower deficit means that they have gotten fiscal policy off."

What's clear here is a meta-point that often gets lost: Evaluating deficit numbers isn't as easy as up-is-good and down-is-bad. In a recession, the deficit is driven as much by the economy as by the government's decisions. High unemployment means there's less income to tax. Sagging demand means there's less in the way of corporate profits to tax. And general economic misery means that programs such as Medicaid and unemployment insurance become much higher because more people need to use them. Deficits are often seen as the product of federal spending, but they're just as much the result of changes in the broader economy. The government's balance sheet is tied to, not separate from, the economy.

When the economy improves, the deficit outlook gets better even though the government hasn't decided to cut spending or raise taxes. But as DeLong's post suggests, even that's not so simple: Textbook Keynesian economics suggests you want to run high deficits during recessions because you need to increase demand after individual and business dollars have fled the economy. But if you remove those deficits at the first sign of recovery, you could remove the very factors that are supporting the economy, which could in turn make the recession worse. So lower deficits during a recession could mean a worse economy, and higher deficits might be a sign that the government is willing to do what's necessary to get the economy back on track.

By Ezra Klein  |  April 13, 2010; 10:46 AM ET
Categories:  Budget , Economic Policy  
Save & Share:  Send E-mail   Facebook   Twitter   Digg   Yahoo Buzz   Del.icio.us   StumbleUpon   Technorati   Google Buzz   Previous: Fighting back against Citizens United
Next: Wall Street reform vs. financial regulation reform

Comments

The question, as ever, is one of degree-- while increased spending might be appropriate in a recession, that isn't to say that whenever we're in a recession, the bigger the deficit is, the better. If the deficit is too large, you enter the realm of crowding out private investment or, worse, systemic/credit/default risk. Instead of running budget deficits that amount to over half of government spending being based on borrowed funds, is there any reason that we can't instead run big surpluses in good times and lower surpluses in bad?

Posted by: tobiasaf | April 13, 2010 12:07 PM | Report abuse

I think DeLong's off on this - the deficit is lower because we're getting our TARP money back and tax receipts are picking up. This actually frees up money for additional stimulus without the need for further-than-anticipated deficits, which I would think is a good thing.

Given that the sum in question is $312 billion, which could easily fund a 9-million strong jobs program, I'd say it's a significantly good thing.

Posted by: StevenAttewell | April 13, 2010 12:09 PM | Report abuse

I don't understand DeLong's point at all.

First, employment is a lagging indicator. So looking at unemployment figures really shouldn't tell us anything about what level the deficit should be at. Rather, the lower deficit should indicate that the employment situation will brighten in the future.

Second, (as tobiasaf said) who's to say that the current deficit level isn't the optimal level? Presumably even DeLong thinks there is some optimal level of deficit spending, even with a depressed job market. Just because the deficit is coming in lower than expected doesn't mean that what we expected was necessarily better.

Posted by: Tractarian | April 13, 2010 12:36 PM | Report abuse

*****But if you remove those deficits at the first sign of recovery, you could remove the very factors that are supporting the economy, which could in turn make the recession worse.*****

Yes, but "removing" the deficit isn't anywhere near on the horizon. We're still talking about red ink in the 9% of GDP range -- much larger than the Reagan deficits that helped power the economy to recovery in 1983.

I think the time to push for larger levels of borrowing was last year -- lots of people conclude the administration didn't get a sufficiently large stimulus package out of Congress. I have to think that time has now passed. My main concern is that the deficit not decline overly rapidly (my own advice would be to extend the Bush tax cuts for, say, another three years, but ideally with a compositional change to make them more progressive).

Anyway, given the connection between the overall economy and the real estate economy, I think the last thing we need is sharpish interest rate increases, so to the extent that a modest and gradual reduction in the deficit manifests itself, we should see some welcome downward pressure on rates.

Posted by: Jasper999 | April 13, 2010 12:36 PM | Report abuse

*****But if you remove those deficits at the first sign of recovery, you could remove the very factors that are supporting the economy, which could in turn make the recession worse.*****

Yes, but "removing" the deficit isn't anywhere near on the horizon. We're still talking about red ink in the 9% of GDP range -- much larger than the Reagan deficits that helped power the economy to recovery in 1983.

I think the time to push for larger levels of borrowing was last year -- lots of people conclude the administration didn't get a sufficiently large stimulus package out of Congress. I have to think that time has now passed. My main concern is that the deficit not decline overly rapidly (my own advice would be to extend the Bush tax cuts for, say, another three years, but ideally with a compositional change to make them more progressive).

Anyway, given the connection between the overall economy and the real estate economy, I think the last thing we need is sharpish interest rate increases, so to the extent that a modest and gradual reduction in the deficit manifests itself, we should see some welcome downward pressure on rates.

Posted by: Jasper999 | April 13, 2010 12:37 PM | Report abuse

*****First, employment is a lagging indicator. So looking at unemployment figures really shouldn't tell us anything about what level the deficit should be at.******

Well, the way I would put it is that the unemployment rate is the sum of all recent job losses. In other words, the large number of job losses in recent times has unfortunately accumulated into, well a large number -- a total larger than the corresponding number a year ago. But the PACE at which the economy is destroying jobs is vastly lower than a year ago. In fact, it appears the economy is no longer destroying jobs at all, but is now creating them.

Posted by: Jasper999 | April 13, 2010 12:42 PM | Report abuse

I agree, I think DeLong is probably off on this. Although I do think there are still reasons to be pessimistic about the the economic outlook, I don't think a smaller deficit is among those reasons, at least not on its face. Changes in TARP costs account for most of this change. To the extent that the reduced cost of TARP represents a misunderstanding of the condition of the financial sector I think it may indicate further economic problems, but that's a financial policy problem, not a fiscal policy problem.

I hardly think revenue increases represent some fundamental misunderstanding of the economy either. Remember that the current budget outlook is based on revisions made after it turned out that the economy was in worse shape than expected. After the revised outlook became the New Truth it was decided that that all projections that existed before were False Prophesies and therefore had to be disregarded, even vilified. Therefore it is not possible that the economy could be in better shape than the Prophets most recently determined. This is the disease of economics, a discipline devoted to finding increasingly complicated ways of precisely predicting the precisely unpredictable.

Posted by: dollarwatcher | April 13, 2010 12:50 PM | Report abuse

1937, my friends: that's when the deficit scolds of the depression-era helped freeze progress in its tracks.

on a deeper level, tobiasaf is on the right track with the first comment: what lord keynes urges upon us is running deficits during times of recession and weak growth and running surpluses during times of strong growth so that over the course of the business cycle, we are in balance.

the problem is not the current deficit, which could continue to be a large number for another 12-18 months without doing us any long-term harm; the problem is that during a period (2002-2008) when the bush administration should have been running a general fund surplus (at a minimum, a general fund breakeven, which is merely what bush promised in 2000 - that was the "lockbox"), it ran enormous general fund deficits.

as a result, the total level of debt is at an unhealthy point.

even so, the solution isn't too choke a nascent recovery; the solution is to commit to a surplus when we see stronger organic growth taking place.

(and yes, i understand that there is no way the current gop would allow us to run a surplus, but that's a problem for another day....)

Posted by: howard16 | April 13, 2010 2:16 PM | Report abuse

Only in Bizarro liberal world does this make sense.

Posted by: Magox | April 13, 2010 2:25 PM | Report abuse

Too all you Keynesians...

Did Keynes suggest running deficits forever?

Posted by: kingstu01 | April 13, 2010 2:46 PM | Report abuse

@kingstu01

No, just recessions. The point of Keynes was to keep demand high by maintaining full employment. Full employment being maintained (or aided, at least) during recessions by government spending to keep demand up where it would otherwise plummet.

Posted by: edwinfirmage | April 13, 2010 2:52 PM | Report abuse

The point is that we laid out a gigantic deficit last year and got no unemployment relief from it. In other words, the stimulus failed.

Posted by: tomtildrum | April 13, 2010 2:58 PM | Report abuse

no, tomtildrum, the stimulus did not fail, as every single review has demonstrated. the simple fact that we had gdp growth as a result of the stimulus makes that clear.

to have had a bigger impact, the stimulus needed to be bigger in absolute terms and more spending-oriented in composition, but it most assuredly had a positive impact.

as for kingstu01, as i had already noted, and as edwinfirmage notes as well, keynes believed in balance across the business cycle. when you - or tomtildrum or any of the other commenters here can show that you were actively opposing the bush tax cuts and favoring a general fund surplus during the bush years, we'll listen to you about deficits....

Posted by: howard16 | April 13, 2010 3:45 PM | Report abuse

Keynesian economics is intended to deal with a context where econcomic problems are caused by inadequate demand. That kind of problem is only one possiblity and not at all what has caused our current problems. The biggest cause of our current problems has been excessive American consumption and the expectation of ever more consumption independent of any consideration of resource limitations or American production. The side effect of this process was the worst excesses in stock market and real estate valuation seen in the records available for the American economy that go back to the later years of the 19th century. All of these excesses produced a badly unbalanced global economy carrying a very large amount of bad debt and widespread unrealistic expectations for future economic conditions. Regaining some kind of balanced global economy is a very difficult process that requires some kind of bankruptcy process to dispose of much of the bad debt in as fair a way as possible and widespread hard decisions as people reconcile their expectations for the future with reality. There is some value in providing a cushion to help get the healthier parts of the economy through a difficult period. But attempts to stimulate people's expectations for their economic futures will just feed the problems.
The most unfortunate part of the deficit problem is that some private debt was transferred to the government balance sheet instead of being written off in bankruptcy. Delaying recongnition of the bad debt does avoid unnecessary collateral damage to relatively healthy parts of the economy. But it also protracts the time of difficulty. We are likely to see several years of both Amercan and global resistance against recognizing the bad debt and the debt that has migrated on to the government's books is more difficult to deal with.
Then there is the unfortunate reality that these debt problems have become entangled with the problems of accounting for people's spending as we enter an era where most people are probably going to be spending a smaller part of their life in the active work force and where the portion of the economy spent on health care is likely to rise. The real debt problem is when we run a perpetual trade deficit as we have been doing to an increasing degree over the last thirty years. On the other hand large government debt where the government borrowed from its working citizens through bonds to deal with shortfalls in entitlement spending might work out well as long as the overall spending level in the economy stayed within the products and services that our real economy can provide.

Posted by: dnjake | April 13, 2010 4:39 PM | Report abuse

The deficit as stimulus story seems to run into some difficulty when we look at the 1920-1921 recession.

This was a recession that was shorter but more severe than the 2007-2009 recession. An industrial production index from the St. Louis Fed shows industrial production declining by 32.5% from Feb20 to Mar21, which compares to the 14.8% drop from Dec07 to Jun09.

http://research.stlouisfed.org/fred2/series/INDPRO/downloaddata?cid=3

Estimates of total GDP decline range from Christina Romer's 2.4% (seems small given the decline in industrial output) to 6.9% per the Commerce dept. Unemployment had much the same trajectory from 1920-1921 as it did from early 2008 to mid 2009. Prices fell by the most in any single year that we have data for. Instead of running deficits, the federal government slashed spending (although it's plausible there was some fiscal expansion at the state level, and the Federal government wasn't entirely laiseez faire).

http://en.wikipedia.org/wiki/Depression_of_1920%E2%80%9321

Full employment returned in roughly a year or two, and the rest of the decade is remembered as the roaring twenties.

I've never seen a good explanation of this downturn (so severe and yet so short and with so rapid a recovery) from an orthodox Keynesian.

Posted by: justin84 | April 13, 2010 5:18 PM | Report abuse

justin84, i don't want to get diverted too far here - the economy of 1921 is rather different than the economy of 2010 - but even a modest acquaintance with the recession in question tells us that: a.) we ran a surplus during the downturn; b.) a level of deflation was accepted by the broader society that is extremely unlikely to be accepted today.

Posted by: howard16 | April 13, 2010 6:04 PM | Report abuse

howard,

Your points about the 1921 economy being very different from the 2010 economy are well taken. But Keynesian economics was a response to the Great Depression. The 1921 economy was quite similar to the 1929 economy, yet we often ran deficits in the 1930s, without any luck in getting back to full employment for a decade.

I don't know much about the downturn, as the GD gets much more press. It does seem to suggest that a severe recession with falling prices, soaring unemployment and contracting bank credit can end relatively quickly even if the federal government runs surpluses.

Posted by: justin84 | April 13, 2010 11:36 PM | Report abuse

justin84, the key point is deflation: insofar as we are willing to let the market clear, the market will clear. the question is whether in letting the market clear, we exact so much damage that the output gap ultimately means we'd have been better off with keynesian stimulus.

Posted by: howard16 | April 14, 2010 10:18 AM | Report abuse

The comments to this entry are closed.

 
 
RSS Feed
Subscribe to The Post

© 2010 The Washington Post Company