• Edward Harrison

Chart of the Day: Government Deficits as Far as the Eye Can See


The chart below from the blog Pragmatic Capitalism shows the U.S. Federal government deficit for each quarter since 1952.

Here’s my take, using the same chart a year ago that Pragmatic Capitalism used above today:

The U.S. dollar is the world’s major reserve currency. Especially in the post-Bretton Woods world, this has meant capital account surpluses as foreigners accumulate U.S. dollar reserves. These capital account surpluses translate into current account deficits. So the „normal” situation, as Randy [Wray] put it, absent a depreciating dollar, is a U.S. current account deficit.  Moreover, Randy writes that a private sector surplus is also normal. And I assume this is true absent some sort of malinvestment-induced capital spending or household dissaving spree. So, while Randy puts normal in quotation marks, I think there is something to this state of affairs being the baseline case for the U.S. sectoral financial balances.


My analysis here says that the Clinton years’ achievement was due largely to a booming economy fuelled by a capital spending binge in the telecom sector and by business generally, mixed with an unsustainable decrease in household savings. Barring a repeat of this – something I would argue is a bad thing – the only way to get around the government deficit is to depreciate the dollar. Right now, getting back to full employment should be the first priority. That would go a long way to reducing the deficit. However, one must  accept that government deficits are inevitable with the world’s reserve currency; the private sector is net saving and the capital account is in surplus. Otherwise, you  really need a major devaluation, a reduction of reserve currency status or a private sector binge. I vote for a reduction of reserve currency status.

How To Reduce Government Budget Deficits


Clearly then, deficits in and of themselves are nothing unusual. What do I think about deficits as far as the eye can see? I would argue they are the norm since government deficits in aggregate allow the private sector to net save.

What about the forward-looking view? Here’s Fed Chairman Ben Bernanke’s take from earlier today:

Fiscal Policy Challenges

In the remainder of my remarks, I would like to briefly discuss the fiscal challenges facing your Committee and the country. The federal budget deficit widened appreciably with the onset of the recent recession, and it has averaged around 9 percent of gross domestic product (GDP) over the past three fiscal years. This exceptional increase in the deficit has mostly reflected the automatic cyclical response of revenues and spending to a weak economy as well as the fiscal actions taken to ease the recession and aid the recovery. As the economy continues to expand and stimulus policies are phased out, the budget deficit should narrow over the next few years.

Unfortunately, even after economic conditions have returned to normal, the nation will still face a sizable structural budget gap if current budget policies continue. Using information from the recent budget outlook by the Congressional Budget Office, one can construct a projection for the federal deficit assuming that most expiring tax provisions are extended and that Medicare’s physician payment rates are held at their current level. Under these assumptions, the budget deficit would be more than 4 percent of GDP in fiscal year 2017, assuming that the economy is then close to full employment. Of even greater concern is that longer-run projections, based on plausible assumptions about the evolution of the economy and budget under current policies, show the structural budget gap increasing significantly further over time and the ratio of outstandingfederal debt to GDP rising rapidly. This dynamic is clearly unsustainable.

These structural fiscal imbalances did not emerge overnight. To a significant extent, they are the result of an aging population and, especially, fast-rising health-care costs, both of which have been predicted for decades. Notably, the Congressional Budget Office projects that net federal outlays for health-care entitlements–which were about 5 percent of GDP in fiscal 2011–could rise to more than 9 percent of GDP by 2035. Although we have been warned about such developments for many years, the time when projections become reality is coming closer.

I have to agree with Bernanke here. There is no reason for the U.S. to maintain a ‘structural’ deficit of 4 percent. It is unsustainable in that it leads to an ever increasing government debt to GDP. And as American society ages, it is probably going to get worse.

From a structural perspective, in the US, the deficit is caused almost exclusively by defense and non-discretionary spending i.e. military spending and entitlement spending (Medicare, Medicaid, and Social Security).Other discretionary spending is pitifully small compared to these items. In fact, if you were to eliminate all non-defense discretionary spending today, you would still have an enormous budget deficit. And I would add that it will kill aggregate demand in the short-to-medium term.  No one wants to touch non-discretionary spending because its politically radioactive to do so. On this score, I agree with David Stockman.

So what about the Cult of Zero Imbalances – the notion that the deficit must be as close to zero over the business cycle as possible? I would agree with Marshall that this is an artificial political constraint. For example, if nominal GDP is growing at 6% and the budget deficit averages 4%, then the debt-to-GDP ratio is falling inexorably toward zero. Is there a need to move toward a zero balance in this situation?

Does focusing on deficit reduction reduce deficits?

I would take the following policy view then:

  • Cyclical deficits are just that cyclical. Raising taxes or reducing spending before you reach full employment is likely to increase these cyclical deficits.
  • Deficit sustainability is an artificial construct. The concept is usually based on a flawed view that taxes fund government expenditures when every dollar, euro, or pound in your pocket is an IOU created by government out of thin air aka fiat currency. Debt-to-GDP constraints are better at framing sustainability. But these too are artificial and are implicit indications of fears of cronyism and government waste.
  • Deficits matter only to the degree they steal real resources from productive use. This can be surmised from a rapidly rising debt-to-GDP ratio.

So, deficits are the norm if you want a net savings position for the private sector. But, yes, I do think the US deficits are too high. We are far from full employment and the promises we have made to Americans on Social Security and healthcare are NPV negative. This ensures a diversion of real resources into those sectors and I believe this will erode growth as it already has in aged economies like Japan, Germany and Italy.


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