Monday, February 13, 2012

Federal budget update; fiscal austerity is not bad for growth


Note how flat spending has been since the end of the recession. Up only 3.7%! Of course, spending rose 23% during the recession, so this is only a modest payback. But it is at least a significant step in the right direction. Hard to believe that we are going to see any major spending initiatives get approved this year. Obama is proposing much more spending, but it's likely to be passed. The increase in revenues post-recession has faded, however. But from the low in revenues in late 2009, we have seen an increase of 14% despite net reductions in tax rates (e.g., the payroll tax holiday).


Federal spending has been very elevated as a % of GDP, well above its post-war average of about 19%, and federal revenues as a % of GDP have been well below its post-war average of about 17%. The increased spending mostly represents a big increase in federal transfer payments (e.g., income redistribution), while the shortfall in revenues can be traced largely to the fact that there are 5 million fewer workers today than there were prior to the recession. Also, the payroll tax "holiday" that has been in effect for over a year now, and that has reduced revenues meaningfully. Unfortunately, that type of tax cut has very little impact on growth, since most consumers view it as only temporary. Tax cuts need to be permanent and across the board to have a decent stimulative effect on growth.


We are still looking at trillion-dollar deficits for as far as the eye can see, but there has been some improvement on the margin in recent years. From a high of $1.48 trillion in early 2010, the deficit has declined by 17%.


As for this last chart, let me say at the outset that it is highly controversial. I don't want to assert here that there is any causal relation between the level of government spending and the unemployment rate. Nor do I want to assert that the official unemployment rate is an accurate reflection of the true state of the labor market. Both assertions could be debated by reasonable people. However, whatever measure of unemployment you prefer, it is nevertheless the case that there has been some improvement in recent years, at the same time as the level of government spending relative to GDP has declined. 

What I do think makes sense and is important to note is that the chart shows that spending can decline relative to GDP (by growing very slowly or not at all), and that is not inconsistent with an improving and growing economy and reduced unemployment. This runs directly counter to the prevaling Keynesian wisdom, which holds that a reduction in government spending (i.e., fiscal austerity) will result in a weaker economy and must therefore be avoided. By not spending more as the economy grows, the government effectively allows the private sector to keep more of what it makes. Since the private sector spends money more efficiently (and less corruptly) than the public sector, shrinking the public sector (even just in relative terms) goes hand in hand with stronger growth. That's just plain common sense. 

Can we confidently predict that more fiscal austerity would translate into stronger growth? No. But neither can we confidently predict that fiscal austerity would result in slower growth. I see this chart as supportive of the case for fiscal austerity, and destructive of the case for continued stimulus. It shows that we can cut back on the growth of spending and avoid increasing taxes without damaging the economy. 

12 comments:

Benjamin said...

Excellent review by Scott Grannis, but what is missing is the consideration of monetary policy.

Running a federal deficit is meaningless, unless accommodated by monetary policy.

And if you want to spur growth through monetary policy, you are better off doing that while running a roughly balanced budget. Let monetary policy do he work, not a mish-mash of wasteful federal spending.

This strategy--Market Monetarism--suggests targeting of nominal GDP growth through interest rates and quantitative easing, and perhaps adjustment of the level of interest on bank reserves.

Sadly, the GOP and Dems are addicted to federal spending and rewarding particular interest groups. Whether ethanol, defense, entitlements, rural subsidies, bullet trains, subsidized energy boondoggles or who knows what, spending is the order of the day.

A ceiling of 16 percent of GDP on federal outlays would be one solution--approved heartily by myself, and all 32 other Americans not tied to the federal budget.

Unknown said...

The last chart is so obvious I can't believe anyone would bother putting the two series atop each other ...

Government spending as a % of GDP goes up during recessions because GDP goes (duh!) down while government spending stays about the same or even goes up (due to stimulus packages). It also so happens that the unemployment rate goes up during recessions (duh!). So, if you put the two on the same chart, it's gonna *look* like they're going in lockstep with one another even though it's basically a coincidence.

Then, naturally, as a recovery takes place, GDP will go up, government spending will (usually) go up less, while unemployment goes down, so the charts together will show government spending as a % of GDP going down while unemployment also goes down. They both have pretty much nothing to do with each other (causally), they both just go up and down together as a natural result of a recession and recovery.

Dr William J McKibbin said...

I agree with the headline -- yes, "fiscal austerity is not bad for growth" -- accredited investors with cash are in a window of opportunity to acquire dividend and rent-earning equities at bargain basement prices -- the "little people" without skills or means are in for austerity and hard times, no doubt -- follow the link below to see where the "little people" fit into the "big picture" of capitalism.

http://wjmc.blogspot.com/2010/07/capitalist-system-according-to.html

I personally weep for those who are suffering in America (which includes some people I know personally) -- however, I do not intend to let this once in a lifetime buying opportunity pass me by...

PS: According to the WSJ, the Greek economy contracted at an annual rate of 7% last quarter -- I wonder what real estate prices look like these days in Athens...

John said...

Sure, and cough drop sales and common colds are tightly correlated, as well. Stop selling cough drops and we'll have fewer colds!

Also, doesn't every transaction involve income redistribution? There are no profits without income redistribution.

By the way, what do you make of the $8.3 billion federal loan guarantee for Southern Company's new nuke? Coundn't they find private equity?

Dr William J McKibbin said...

PPS: America is still the land of opportunity -- unlike Saudi Arabia, where one must be a crown prince to become a fighter pilot or surgeon, America offers a success path to anyone willing to study hard and acquire skills that earn premium wages -- my advice to young people is choose a major that earns exceptional wages in any economy such as medicine, actuarial science, or engineering -- then convert those skills into money and equities over a lifetime -- it's that easy (or hard) -- my other advice for young people is to avoid college majors that do not earn premium wages (unless you have money already or intend to marry into money) -- life is both easy and hard, but you cannot waste your talents and time hoping to get there -- my advice to everyone is acquire equities and hold them for life -- and don't look back!

Dr William J McKibbin said...

@John, your comment about spurious correlations is spot on!

Donny Baseball said...

Analysts constantly refer to debt held by the public to refer to our real debt as opposed to our actual liabilities. They've had a point because our non-bonded debt was always off in the future and times were relatively good for so long. IHMO it is no longer valid to ignore non-bonded debt, because - it is clear to me - that this non-bonded debt is getting converted to bonded debt at a rapid pace as we speak. Entitlement spending is racing ahead and we are issuing gargantuan amounts of bonds to fund it. The entitlement bomb is not set to go off, it is going off and we are still focused on the level of bonded debt when we are adding to that as well as finally bonding these "promises" that we've ignored for so long.

Still, it amazes me that in the face of what Obama is doing to the fiscal health of our country that the treasury market can shrug it off. I can't help but think the adjustment will not be pretty.

Dr William J McKibbin said...

@Donny Baseball, you said, "Entitlement spending is racing ahead and we are issuing gargantuan amounts of bonds to fund it." Don't forget that the US is also borrowing to fund "defense" spending and wars overseas (or is it that all of the borrowing should be allocated to entitlement spending). As far as I am concerned, both entitlement and defense spending should get an immediate 40% haircut right now...

Donny Baseball said...

William-
While I appreciate the fiscal probity of big cuts to both guns and butter, I object on the grounds that military spending is actually within the constitutional purview of the federal government, whereas entitlements are not. I further support my case on the basis that a portion of military spending actually leads to innovations and useful new technologies, whereas something like Social Security does not. Having said that, military spending is inefficient and bloated, it could use a forced hand to get a bit more efficient, say a 10% cut. Finally, I rest my case on history, a weak and demilitarizing USA means bad things will happen on the global stage. I consider us the good guys and I want the good guys to always have the best and most guns - 40% cuts will take that advantage away, 10% will not.

L.A. said...
This comment has been removed by the author.
L.A. said...

For all those hating the bottom graph and correlation, Scott makes it blatantly obvious he is not saying there is a causal relation.

"As for this last chart, let me say at the outset that it is highly controversial. I don't want to assert here that there is any causal relation between the level of government spending and the unemployment rate."

The two are correlated. It is up to the interpreter to assess deeper meaning and any causation.

Dr William J McKibbin said...

@Donny Baseball, the military can provide more defense for far fewer dollars -- I will not make that case here, but US citizens are getting far too little defense for far too many dollars -- like I said, 40% cuts to both guns and butter is what Republicans should be pursuing -- America desperately needs a "balanced budget" party -- by the way, if eliminating social spending will do the job, then that's fine with me, too -- I want the budget balanced, one way or the other -- that's what my vote is looking for -- once the US budget is balanced, then we can start to talk about cutting government spending by another 40% using technology...