April 14, 2009
Manipulating Budget Deficits
By Wade Rousse
Advocates of an aggressive fiscal policy and big spending usually argue that it’s the government’s responsibility to be the “spender of last resort.” Government should run a larger budget deficit during economic downturns and narrow the deficit during economic booms, they say. If implemented correctly, this approach will result in a smoother business cycle, they believe.
This makes economic sense. However, during a recession deficits automatically increase because the economy has built-in stabilizers. For example, during economic downturns incomes usually fall and as a result people pay less in personal income taxes. Profits also fall, which results in corporations paying less in corporate income taxes. And more people become eligible for benefits like welfare and unemployment payments during a recession, so government spending automatically goes up.
Obviously, these stabilizers will increase the budget deficit during a recession. Do you think they are being adequately factored into the recent budget deficit analysis? And do you think they will be sufficient in bringing the economy back to full employment?
Posted by Wade at April 14, 2009 6:27 PM
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I'll answer the second part first. Yes I think that the economy will recover from the financial crisis, (if it goes south in the future I expect it to be because of government debt financing issues, trade imbalances being balanced, or government scaring investors/giving unions unjustified and just plain wrong support). I subscribe to the efficient market hypothesis holding true for goods and services markets. With the Feds actions actions to stabilize assets and credit, eventually inventories would be corrected and employment begin to increase again. In terms of the information of increased safety net spending being factored into the deficit projections, I cannot say for sure. I would assume that it is factored in (especially once the economy recovers, but I don't know). I will say though that special programs, such as Fannie and Freddie during the depression, have a way of outliving their usefulness. In order for increased spending during downturns to work repeatedly from contraction to contraction, government needs to cut back during the boom times. Neither party seems to be pursuing that course of action right now though.
Posted by: little David at May 3, 2009 4:41 AM
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