The Deficit Dilemma

Here at "A Dash" we have emphasized a certain type of dilemma for policymakers.  One side of the issue has a position that seems obvious.  It is easy to explain in terms that resonate with the average voter.  The other side is more complicated.  It might involve some abstract modeling.  It might require economic analysis.  The consequences of the decision might not be readily visible and traceable to those affected.

Budget deficits are like that.

The fiscal stimulus program, coming at a time of declining revenues, means that near-term deficits loom large.  FT Alphaville, (now added to our list of featured sites), frequently does a nice job in setting up issues of this type.  Izabella Kaminska first looks to commentary from Harvard history professor Niall Ferguson.  While he gives the Obama administration good marks on various fronts, Ferguson sees the deficit problem as a major issue.

A nice feature of the FT Alphaville approach is the combination of various viewpoints with some commentary and other sources added.  In this case, the addition is a scary chart from Sean Corrigan of Diapason Securities.

Kaminska logically concludes, "We can see why that would be scary to voters."

There is another viewpoint, of course.  With an economic consensus behind the idea of fiscal stimulus, it is wise to consider that argument.  For a plain English explanation, understandable by anyone taking two minutes to read the article, we turn to economist L. Randall Wray.  (Hat tip to Phil Izzo at the WSJ)

He carefully explains the mistake made by anyone who has not really studied economics:

One of the most important concepts to be taught in economics is the
notion of the fallacy of composition: what might be true for
individuals is probably not true for society as a whole.

There are many good examples in this article, but the crucial point for deficit spending is that there is an equation linking private sector spending, government spending and the trade balance.  In general, private saving is offset by government deficits.  Government surpluses have historically implied private deficits.

Budget deficits represent private sector
savings. Or another way of putting it: every time the government runs a
deficit and issues a bond, adding to the financial wealth of the
private sector. (Technically, the sum of the private sector surpluses
equal the sum of the government sector deficits, which equals the
outstanding government debt—so long as the foreign sector is balanced.)

and later…

The question is whether the US government can
run deficits forever. The answer is emphatically “yes”, and that it had
better do so. If you look back to 1776, the federal budget has run a
continuous deficit except for 7 short periods. The first 6 of those
were followed by depressions—the last time was in 1929 which was
followed by the Great Depression. The one exception was the Clinton
budget surplus, which was followed (so far) only by a recession.

Professor Wray, Research Director with the Center
for Full Employment and Price Stability and Senior Research Scholar at
The Levy Economics Institute, does not argue that large deficits are always good.  He is simply highlighting an economic reality that few understand.

Our Take

The policy choice of a greater government deficit right now fills a gap in private spending.  It is not like one's household budget.  It is a problem of balance and restoring economic growth.  The Administration viewpoint is that is that deficit reduction is best achieved by stimulating the economy.  This means larger deficits in the short run.

While many dismiss the stimulus package effects, some for political reasons, the program impacts have just begun.  Much of the spending is spread out over the next eighteen months.

Whether this will work depends upon many factors, including possible additional economic shocks.  No one really knows the answer, but the incipient effects are quite large.  Despite this, some think the program was too small.  We expect growing profits from companies that have dramatically cut costs.

Some disagree with this conclusion, and that is what makes a market.  Whatever your conclusion, it is a problem that is not as simple as viewing government in the same way as one's family budget.