Time to Throw Some Water on The Deficit Hysteria Fire

CAN OR SHOULD THE FEDERAL GOVERNMENT BALANCE ITS BUDGET?
Yeva Nersisyan and L. Randall Wray

Nowadays the only thing on everybody’s mind is the level of government deficit and national debt. Deficit hysteria is being fueled by reports that the US budget deficit will reach “an all time high” this year. President Obama is going to appoint his own commission to study how to reduce the deficit—since Congress failed in its attempt to establish one. He frets that we will leave crippling mountains of debts for our grandkids. The deficit hysteria hydra is too big to cover in one blog—but here we will address the “deficit cycle” and the possibility of ending it.

There seems to be a deficit mania cycle with hysteria arriving after every recession (because, as we show below, recessions always generate big deficits), only to recede when economic growth resumes and deficits fall. And the fact that there is a Democratic president in office and a largely Democratic congress frees the hands of conservative deficit hawks who complain about spending profligacy and growing national debt (they usually fail to recall that much of this spending and especially tax cuts have been generated under a Republic president and Congress, not to mention the 780 billion Paulson bailout of Wall Street). This deficit hysteria is also a useful tool for distracting people’s attention from really important matters, such as a 10% unemployment rate, the possibility of a double-dip recession, underwater home owners, and rising mortgage delinquencies.

Can the government really balance its budget and run continuous surpluses for a number of years as some politicians promise to do? Here is some data to help you decide that for yourself. Every time the government has tried to balance its budget, the economy has fallen into a recession which has caused the automatic stabilizers to kick in and grow the budget deficit. The graph below depicts the federal budget deficit (or surplus) as a % of GDP with signs reversed (a surplus is below zero, a budget deficit is shown as above zero) and recessionary periods for the entire post-war period. As can be observed in this graph, every budget surplus over this period has preceded a recession. The remaining recessionary episodes have been preceded by reduction of the deficit to GDP ratios. Further, every recession except the one in 1960 led to a budget deficit; the 1960 recession was followed by a reduction of the budget surplus.
These movements of the budget balance are due to automatic stabilizers. When the economy slides into a recession, tax revenues start falling as economic activity declines. Social transfer payments, particularly unemployment benefits, on the other hand, increase, again automatically, as more people loose their jobs. On the other hand when the economy begins to grow, tax revenues grow quickly, moving the budget toward balance or even to a surplus.
The graph below shows the rate of growth of tax revenues (automatic), government consumption expenditures (somewhat discretionary) and social transfer payments (again automatic) relative to the same quarter of the previous year:

While government consumption expenditures have remained relatively stable after a short spike in 2007-2008, the rate of growth of tax revenues has dropped sharply from 5 % growth to 10 % decline in just three quarters (from Q 4 of 2007 to Q 2 of 2008), reaching another low of -15% in Q1 of 2009. Transfer payments, as expected have been growing at an average rate of 10% since 2007. Decreasing taxes coupled with increased transfer payments have automatically pushed the budget into a larger deficit, notwithstanding the change in consumption expenditures. These automatic stabilizers and not the bailouts or much-belated and smaller-than-needed stimulus are the reason why the economy hasn’t been in a freefall similar to the Great Depression. As the economy slowed down, the budget automatically went into a deficit putting a floor on aggregate demand.

Conclusions: the federal government budget cannot be balanced or turned into surplus without killing the economy and causing another Great Depression, which again, will automatically cause the budget to turn into the negative territory. With the loss of 8 million jobs, and given the private sector’s unwillingness to go further into debt (it is now, finally, spending less than its income) there is no way that the federal budget can be balanced, unless the US becomes a net exporter, which is highly unlikely. So if a politician tells you that she is going to balance that budget, she either doesn’t understand what she is talking about or is trying to fool you to get elected.

11 Responses to Time to Throw Some Water on The Deficit Hysteria Fire

  1. Looks like you are missing the graphs?

  2. Dr Wray, things are getting pretty scary(in terms of deficit hysteria) if you listen to what is being reported in the media. Deficit reduction seems to be the central platform of the tea party movement and both of the major political parties are lining up behind this dogma. It seems the public at large associates the deficit, perhaps subconsciously, with high unemployment and economic malaise that we are experiencing today.

  3. Timely, well argued and right. I have just discovered this blog and I really like it. It's appalling the way the economic thinking which got us into this mess has bounced back. The Obama Administration has to take much of the blame for this because it has nott stood clearly for a change in policy.

  4. Thanks for the nice comments. Please note that we did have a technical problem with the graphs. Now they are not only posted here, but if you click on them you will get them sized so that you can actually read them!!!Yes the hysteria is scary, truly unbelievable. Help to put out the fire!LRWray

  5. the conservatives are freakin morons, and it helps (them) that their consituents are too.apj

  6. Dr. Wray, I've recently read Understanding Modern Money and it's completely changed my mind regarding deficits. Yet I hear other voices I respect, who are in agreement about current deficit hysteria, such as Paul Krugman and James Kwak, still expressing concern over long-term deficits. From what I understand, can't -any- deficit essentially be addressed by inflationary fiscal and accomodative monetary policy? And the "threat" of inflation simply resolved by taxation? Is there something "special" about long-term deficits I don't understand? My apologies for my ignorance; I am musician, not an economist! Thanks…

  7. Can it be that the Tea Party brownshirts are going to annoint Joe Stack as their Horst Wessel? Andrei Vyshinsky

  8. James Call: a deficit can be too big, causing inflation. Yes the solution is to reduce it down to a level consistent with full employment, either by raising taxes or cutting spending. I do not know of Kwak. I think Krugman is getting closer to understanding budget deficits, but still has some way to go. Note that with an employer of last resort (job guarantee) program, the govt deficit is always at just the right size to give full employment–so you don't need to worry about it causing inflation if you rely on that part of the budget to do the stabilizing. LRWray

  9. it would be nice if a chartalist/ modern monetary theory person would address america's bloated health care costs as a % of gdp and how that relates to government budgets. its seems to me that health care spending in america has been bloated by inelastic demand from both government and insurance companies.

  10. It is glad to see this blog, it is good and detailed fun to read this, nice informative blog, Thanks for share this article.

  11. Looking at that graph, all of those recessions are not only preceded by surpluses, but also sharp reversals in government deficit spending. How can you say that the recession was caused by the gradual reduction in deficit spending rather than the sharp and unexpected increases in government deficit spending? I think you're missing something here.Another thing I notice is that theres large periods of non-recession as government deficit spending is reduced. It makes far more sense to me that these recessions are caused by sharp unexpected reversals in government spending. This would infuse the economy with false demand, catch businesses by surprise and force them to overcompensate. The resulting over production sees a less than expected demand would throw the economy into a downward spiral.I think you're not seeing the harm in government spending – money isn't simply created, its taken from people who would otherwise be investing in things that will better people's lives, rather than in wasteful government projects. As far as I can see, its the increase in government spending that causes these recessions.