Thursday, March 26, 2009

The economy must take priority over worries about deficits

After ignoring the buildup of deficits during the Bush years, so-called budget hawks are now “shocked” about the federal government’s projected deficits over the next four to ten years. Of course, they overlook the fact that our economy is in very real trouble and spending cuts at a time the economy needs stimulation will only prolong the bigger problems. And they also overlook the fact the best way to address deficits is to have a healthy economy.

Dean Baker explains:
…budget hawk[s]… are upset that the deficits projected for 2013 or 2019 are too large. They want President Obama to commit to spending cuts and/or tax increases in order to bring these deficits to levels they consider acceptable.

The unreality of this picture is striking because the budget hawks seem not to notice that we are in the middle of an economic meltdown.

People are losing their homes through foreclosures at the rate of more than 100,000 a month. The default rates on credit cards, car loans and other debt is at record levels. Most of our major banks are effectively insolvent.

Home and stock prices have plummeted, destroying most of the wealth of the baby boom cohort as they stand on the edge of retirement. The economy is shedding almost 700,000 jobs a month, with the unemployment rate rapidly approaching the highest level since the Great Depression.
In this context we are supposed to be up in arms over the deficit projections for 2013 or 2019? This is a bit like someone complaining about the lawn not being mowed at a time when the house is on fire, it's just not the first priority. And the media all seem to go along with the charade - yes, they are very concerned about the projected deficit for 2013 …


The moral to this story is that the economy must take priority, not only because the state of the economy is what most directly determines people's well-being, but also because the state of the economy will be the most important determinant of the deficit.

The experience of the 1990s provides an example of exactly this sort of story. In January of 1994 the Congressional Budget Office projected that the deficit in 1999 would be $204 billion or 2.4 percent of GDP. This projection incorporated the impact of President Clinton's tax increase and spending cuts.

It turned out that there was a surplus of $125 billion in 1999, or 1.4 percent of GDP. This shift from deficit to surplus of 3.8 percentage points of GDP (equivalent to $540 billion in 2009) was not caused by further spending cuts or tax increases, it was caused by the strong economic growth of the period.

There is no guarantee that President Obama's policies will be successful in restoring strong growth, but they are clearly a step in the right direction. If we have strong growth, then our deficits will be manageable. If the economy remains weak, the deficit will remain a serious burden no matter how much we raise taxes or cut spending.


Comrade Kevin said...

FDR ran in 1932 on two premises that contradicted each other altogether: to increase government spending and to balance the budget. Clearly both cannot happen simultaneously.

Taxes will need to be raised as they were then and some degree of deficit spending will have to exist as well. There's no way around either.

Paul Hammond said...

Continental Europeans apparently disagree, but then their social safety net shields their citizens from the worst effects of unemployment and acts as different form of stimulus, by keeping money in the their hands.

The economic summit should be interesting. I'm sure Obama will put on a good show as usual.