Wednesday, April 11, 2012

Federal budget update

Today's release of March federal budget numbers was mixed. Three broad themes remain in place: 1) annual outlays have grown very little since the recovery started (only $90 billion), thanks to Congressional gridlock; 2) revenue growth has slowed over the past year, thanks to the payroll tax cut and only moderate growth in jobs; and 3) the budget deficit continues to decline relative to GDP (from a high of 10.4% in late '09 to 8% now), thanks mainly to increased tax revenues and stagnant spending. If Congress can continue to hold the line on spending, and if the economy continues to grow, the budget deficit will slowly fade away as a pressing problem—but of course this could take many years.

I can't resist posting an updated version of this chart, even though every time I do, it creates a storm of controversy. Students of the business cycle know that a recession typically leads to increased spending (e.g., automatic stabilizers such as unemployment benefits and food stamps kick in), so it is natural for spending to increase relative to GDP (blue line in the above chart), at the same time that the unemployment rate increases (red line). Similarly, recoveries reduce unemployment and that takes some pressure off of spending. But the most recent recession was an outlier, since it featured a surge in spending the likes of which we haven't seen since WW II. This time around, spending wasn't just driven by an increase in unemployment benefits and automatic stabilizers, it was also driven by Washington's attempt to seriously boost spending on things that were supposed to strengthen the economy. But as we now know, a trillion dollars of "stimulus" spending failed to boost the economy and failed to bring down the unemployment rate as its proponents had argued.

My point here (which is difficult to prove, I know) is that "stimulus" spending actually ended up weakening the economy, and that is why the level of spending relative to GDP is still very high and the unemployment rate is still very high. When the government redirects a significant amount of the economy's resources in the name of "stimulus," what it is actually doing is hobbling the economy by taking money from those who are more productive and giving it to those who are less productive. Transfer payments have surged, unemployment benefits have been extended in unprecedented fashion, and "stimulus" funds have been wasted on "make-work" projects. None of this helps create jobs, and in fact the incentives for new job creation have only declined, due to increased regulatory burdens and the fear that huge increases in future tax burdens will be required to reduce the bulging federal debt.

The implication here is that since deficit-financed spending increases can weaken an economy, reductions in spending relative to GDP can strengthen an economy. We're on that virtuous path to some extent, and that is why the unemployment rate is slowly declining. But it would be far better if we—and the Europeans—could make a more vigorous effort to reduce spending relative to GDP. That's the kind of "austerity" that leads to a stronger economy.

UPDATE: It occurs to me that there is another reason for why the huge increase in spending vs. GDP in recent years has corresponded so tightly to the unemployment rate. The unprecedented expansion of unemployment benefits and the equally unprecedented increase in food stamp benefits in recent years has undoubtedly played a role in reducing the labor force participation rate (many people may have decided to stop seeking employment in order to enjoy extended/emergency unemployment benefits and food stamps), and the reduction in size and lack of growth in recent years of the labor force has been an important contributor to the decline in the unemployment rate. I don't have facts or figures to back this up, but it does seem intuitive.


Bill said...

It looks like revenue is starting to collapse which might be a precursor to a new recession.

Squire said...

Most government money is spent on consumption. If you borrow the money there is no rate of return on the debt. The money velocity eventually disappears and the money is gone but the debt remains. I would call that bad debt as it isn’t backed by any assets.

Benjamin Cole said...

Nice blogging, but Scott Grannis fails to take into account perhaps the met important aspects of federal macroeconomic policy---the federal Reserve's monetary policy.

I'd like to see the federal budget balanced (and each state get back roughly what they send to DC, no more rural subsidies) at 18 percent of GDP, and a robust, bullish Fed interested in economic growth.

Long-term the goal should be a federal government at 16 percent of GDP.

Surely we can live without USDA, HUD, Commerce, Labor, and cut Defense by two-thirds.

Hold the line on Medicare, through vouchers, and even paying for overseas care.

Raise Social Security retirement age to 70, and to 65 for all federal employees, in defense or anywhere else.

We can have economic prosperity--but I thin we would have to have Ron Paul as President and Milton Friedman as head of the federal Reserve.

McKibbinUSA said...

Deep cuts in government spending would be fine with me -- say, 90% in both defense spending and entitlements -- either the US goes down the road of monetary expansion with gusto, or savage cuts in government spending with abandon -- now that monetary expansion has been flatly rejected by the Congress, it's time to proceed with austerity measures galore, and by that, I mean the near elimination of government...

McKibbinUSA said...

The first step should be to cap all government pay and pensions at $25,000 annually -- that will encourage government employees to seek work in private enterprise -- let's face it, government employment should be about sacrifice for the community and society...

Benjamin Cole said...

Dr. McKibben-

I have often thought the same thing---government service should have no pensions attached, either locally or at federal level, including military.

It should be a young person's game, where they get experience, serve with gusto, and then take that experience and move into the private sector.

Why are we paying young men to loaf around after 20 years of federal service?

The Roller said...


Why pay people to become professional loafers as government employees?

Because many politicians, public service unions, and campaign contributors derive their power from it.

Doc William.

If we are to cut spending on defense, who would you suggest in the #1 spot? China? Russia? Iran?

Squire said...

Bernanke said (Bloomberg) :
Following the collapse of the housing bubble, regulators will take steps to guard against another large decline in home prices, Bernanke said.
“Obviously, we have already taken steps and the Consumer Financial Protection Bureau will continue to take further steps to provide additional protections and try to avoid any similar event in the future,” Bernanke said.

We have a new protection bureau that needs to be funded.

Squire said...

Government spending uses up capital, wasting it on lifestyle spending which reduces capital available for productive purposes. Oh. I forgot. We can borrow as much capital as we want and print the rest. Besides, the rich have plenty of capital we can draw on.

Benjamin Cole said...

The Roller-

China, Russia nd Iran are not serious threats. We can radically downsize our military.

In its dark heyday, Russia had millions of men in uniform, hundreds of submarines, thousands of tanks (and many more under production, a blue water Navy, and Air Force, a KGB, satellites, thousand of nuke-tipped missiles pointed at us etc etc etc.

That was a threat.

A few punk terrorists are not a threat.

Fearmongers who want more federal waste try to make it sound like we face threats but we really don't.

And we are spending $80 billion a year in military R&D!! It is an unstoppable drain on productive taxpayers.

The USA used to demobilize after wars. We should now. We can remobilize if we face some threats worth the bother.

Bob said...

"A few punk terrorists are not a threat."

Tell that to the three thousand dead on 9/11.

There is merit in reconstituting our military to fit modern world threats and conditions. But wholescale 90% reductions is ridiculous. Defense spending is at all time lows in relation to GDP, just barely 4% I believe.

One can argue legitimately how and how much to spend on the military/defense, but that money is not where the problems lie.


Vespasianus said...

That's a sensible post. My personal experience in a country like Spain, with more than 22% official unemployment rate, is that the unemployed tend to consider the benefits for unemployment as an income rent, rather than a timely solution. In the period they are eligible, most would reject a job offer, because if they get a part time job in the informal economy, they make more money than earning a conventional salary subject to tax.

Louis Cyphre said...

Mr. Grannis, sorry for the off-topic, what’s your take on the DOJ move against Apple?

Scott Grannis said...

Re: Apple and the DoJ. To begin with, since selling ebooks is a very small part of Apple's business, I don't think this suit will have much impact on AAPL regardless of how it turns out. But as for the suit itself, I think this is one more example of federal overreach. I see merit in the comments made by Richard Epstein in this article:

McKibbinUSA said...

@Bob, I used 90% as a starting point -- as far as I am concerned, the cuts should be closer to 99%, especially in defense spending -- the world has changed forever -- part of that change is the US is broke -- if the US cannot figure out how to cut spending drastically, then perhaps the US should reconsider monetary expansion -- but, the status quo is dead -- only old people born before 1965 believe in governmetn spending at current levels -- the other option is to fold the flags up on the USA and run everything at the state level..

Bob said...

@ Doc Mckibbin "only old people born before 1965 believe in governmetn spending at current levels"

Well I was born well before '65 (1947) and I don't believe gov't spending should be kept at current levels.

The U.S. is not broke, it is indebt. Under the right circumstances that debt can be worked off through economic expansion. Albeit I concur that currently that prospect looks dim.

The idea that defense spending would not exist, that we would not have a military capability, covert intelligence, or any defense at all is absurd, IMO. You sound like Ron Paul.

I do agree that there is much waste in defense (and in all government programs) that should be addressed and that the roll of the military has changed and should be examined.