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Budget deficits reflect economic conditions, not just government policy

budgetproblems.jpg

A better way to make the point I was trying to make in this post is to say that people overestimate the degree to which budget deficits are a reflection of government policy rather than a reflection of background economic conditions. A set of policies that were balancing state budgets in 2004 and 2005 and 2006 and could've survived a mild recession but weren't able to hold the line against a once-in-a-generation economic storm aren't bad or profligate policies: It's just hard to endure economic catastrophes, and you wouldn't necessarily want to orient your economic policy around long-tail events. A pension program that was started in the early 1900s and that's worked pretty well but will run a temporary deficit when an uncommonly large generation retires isn't a poorly designed pension program.

In the current context, the main point here is that big deficits aren't being caused by stimulus spending or bank rescues or anything else: They're being caused by unemployment, which destroys tax revenue. This is true in the states, it's true in the country, and as the IMF graph atop this post shows, it's true worldwide. But because people tend to think of deficits as a measure of fiscal responsibility rather than an indicator of broader economic conditions, this gets mixed up, which also means that what we should do about the temporary rise in deficits gets mixed up.

By Ezra Klein  |  June 22, 2010; 2:16 PM ET
Categories:  Budget  
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Comments

I agree with your basic point--that the current fiscal mess the states are in is the result of economic conditions. But you keep mentioning state pensions, and the problems facing state pension systems are NOT the result of current economic conditions, or even a demographic bulge. They are the result of decades of mismanagement, specifically the use of unsound actuarial assumptions as a means to avoid having to set aside sufficient funds every year.

Stop using pensions as an example, and your point will make sense.

Posted by: BobN1 | June 22, 2010 2:31 PM | Report abuse

It's just silly to say "it's not that they budgeted badly, they just budgeted assuming there would never be any bad times." A bad economy was inevitable sooner or later, and instead of preparing for the possiblity, state governments spent wildly in good times, raising their budgets as much as 40% in the last few years before this recession. There's no reason states should insist on maintaining their spending at the highest level they ever achived in 2008 or so, and the economy won't crash if they are forced to cut back to the levels of, say, 2006.

The question is, how much economic benefit comes from forcing the next generation to pay so that your DMV doesn't have to cut a single job today, and could we achieve more dynamic job creation by spending that money elsewhere? Bus drivers in NYC, as of 2006, can retire on a pension at age 55; do we really want to direct our children's taxes to support that lifestyle, or are there other, more productive uses for that money that will bring about a better future for all of us?

Posted by: tomtildrum | June 22, 2010 2:42 PM | Report abuse

He Ezra, can you get on the phone and explain that to David Brooks? 'Cause his column today seems to center, in part, on the idea that Obama' policies have caused record deficits while failing to fix unemployment, and that's why everyone is so mad.

But as you so clearly state, the deficit was gonna spike whether or not Obama changed even one itty bitty policy.

Posted by: RalfW | June 22, 2010 2:45 PM | Report abuse

This can be explained at a more fundamental level still, by looking at the sectoral balances:

The public deficit is necessarily the exact complement, dollar-for-dollar, of the sum of the current account deficit and private sector net savings, as in those charts that Yglesias keeps posting:

http://farm2.static.flickr.com/1276/4710264588_5c04e2813d_o.gif

This means that, for any given level of national income, the demand for a lower deficit necessarily entails a demand for one of the following corresponding adjustments:

a) More exports (implausible without a much lower dollar); or

b) More private sector debt (implausible without more curing of private sector balance sheets); or

c) Some combination of a and b.

There is no fourth option. Or rather, the fourth option is that you get your deficits anyway, after a failed attempt to reduce them, but at a lower level of national income, which adjusts downward as the private sector goes further in the hole they are trying to crawl out of.

Posted by: amileoj | June 22, 2010 3:14 PM | Report abuse

"A set of policies that were balancing state budgets in 2004 and 2005 and 2006 and could've survived a mild recession but weren't able to hold the line against a once-in-a-generation economic storm aren't bad or profligate policies"

If an individual lives paycheck to paycheck (balanced budget) during good times, we would consider him to be mismanaging his money. The furnance needs replacing, and he goes into debt. He is unemployed for three months and goes into debt. His roof needs repaired, still more debt. This type of fiscal management is unsustainable.

We all get that recessions reduce revenue and that reduction is primarily responsible for the state budget shortfall. What we're trying to convey is that the states shouldn't have been starting with balanced budgets. Had states run a modest $50 billion annual surplus from 2004-2007, they would have had not only lower deficits today but also $200 billion + interest to plug the holes (and delightfully, the states would be able to contribute to fiscal stimulus if you believe that sort of thing helps - I'd even venture to guess Keynes would recommend this approach).

By the way, the 'once in a generation economic storm' of this magnitude happens fairly often. Unemployment hit 9% in 1975, 10.8% in 1982, 10.1% in 2009 - three storms in the career of a boomer who entered the workforce in 1973.

Posted by: justin84 | June 22, 2010 3:23 PM | Report abuse

I've been thinking, and this bump you speak of makes no sense.

It has to have been poorly planned for a couple of reasons:

- The number of people paying in is SMALLER than that of the people who are cashing out. This is because they are essentially paying into their own retirement until they can cash in. A fair number of people don't make it for various reasons and their funds are absorbed.

- The money being collected from those who are planning for their own future should be essentially coming back to them in the long run, not used for the aging population.

The only excuse that makes sense to me, is that retiring at 65 no longer means 5-10(sometimes more) years of drawing a pension, with a large percentage of people not making it. It means 5-25 (sometimes more) years of drawing that same pension with few people not making it. That adds up quickly, and that is how you get into the current mess today. Combine that with any of the possible miscalculations made by the administrators of the fund (estimating cost of living, inflation etc) and it's no wonder. Not that I believe that anyone could have predicted the lifespan increase accurately or prepared for it.

The bump where people are retiring en masse is not the root of the problem, it's just exacerbating it, causing the pensions to be a redistribution of wealth rather than a true savings program.

Posted by: akusu | June 22, 2010 3:40 PM | Report abuse

This post definitely gave me my laugh of the day. During the Bush administration every liberal including Ezra was repeating the mantra that the Bush tax cuts caused the deficit. Now that Obama is President, it is not his fiscal policy that is causing deficits it is the economy. You guys crack me up.

Posted by: cummije5 | June 22, 2010 4:25 PM | Report abuse

The reason it's irresponsible is this, when revenue drops, they don't cut spending. When revenue rises, they don't create a rainy day fund. It does make sense to borrow to get across a revenue dip, but you need to compensate by not wildly increasing spending in the good times.

This is still a completely absurd article. I would ask, what causes unemployment? Klein would seem to suggest that we hand out more government jobs to solve the unemployment problem, but where do the tax dollars to pay for those come from?

Defined benefit pensions should be illegal.

Posted by: staticvars | June 22, 2010 10:54 PM | Report abuse

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