Tuesday, July 29, 2008

What Record Deficits Teach Us

It is significant news that the Bush administration is expected to leave office with the federal budget showing a record $482 billion deficit. There's even some added outrage that defense appropriations for Afghanistan and Iraq are held "off-budget," which ostensibly swells the numbers even further.

It's interesting, though, that liberal economist Dean Baker notes that in terms of deficits as a percentage of GDP, the Bush budget legacy should be less controversial than his predecessors:

The latest projections show a deficit of $490 billion. By the absolutely meaningless measure of nominal dollars this is a record. But if anyone thinks this is giving information to readers, then they have no business writing news. The relevant measure is the deficit as a share of GDP. The 2009 deficit will be equal to about 3.3 percent of GDP. Even if you add in 1.3 percent of GDP for the money borrowed from Social Security this only gets you to 4.6 percent, well below the 6.0 percent deficit hit in 1983.
President Reagan was in office in 1983, which leads Matthew Yglesias to hammer home the point, with reference to the following graph:

Budget Deficits

Dean observes that "the 2009 deficit will be equal to about 3.3 percent of GDP," similar to the deficits earlier in the Bush administration and to the deficits ran in the mid-1970s. The real "record" deficits hit in the 1980s and early 1990s were substantially larger than today's deficits.

This visual display of quantitative information helps put things in perspective. Yglesias focuses on the "real" record deficits, which preceded President Clinton's two terms in the 1990s.

But note how President Bush's budget legacy at 3.3 percent of GDP is roughly equal to the deficit graphed in 1968, near the end of Lyndon Johnson's presidency. According to the data, the fiscal situation moved to surplus in President Nixon's first term and then deteriorated following the Johnson adminstration's global monetization of America's balance-of-payments difficulties, as well as the exogenous oil-shocks of the 1970s. After the initial "record" budget shortfalls of the Reagan years, the deficit neared 2.5 percent of GDP by 1989, not much different from where we stand today.

What seems clear is that a Democratic Bill Clinton administration is the exception to a U.S. fiscal policy pattern of deficit-financed economic growth. Further, the implications of the pattern of long-term budgetary imbalance remain unclear, given the size, dynamism, and resilience of the U.S. economy.

As Paul Samuelson noted in the 1990s:

Those who study economics or make economic policies ... will confront the need to service a large external debt and the possibility of sluggish economic growth. But in the midst of today's tempest, keep in mind the observations on growth and debt of the English historian Lord Macaulay, written more than a century ago:

At every stage in the growth of that debt, the nation has set up the same cry of anguish and despair. At every stage in the growth of that debt, it has been seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt went on growing; and still bankruptcy and ruin were as remote as ever.

The prophets of evil were under a double delusion. They erroneously imagined that there was an exact analogy between the case of an individual who is in debt to another individual and the case of a society which is in debt to a part of itself ... They made no allowance for the effect produced by the incessant progress of every experimental science, and by the incessant efforts of every man to get on in life. They saw that the deficit grew; and they forgot that other things grew as well.

What can Macaulay teach us ... ? We can hardly doubt that high fiscal deficits are producing an unprecedented growth in ... debt in the United States....

But it would be unwise to forecast economic collapse. The spector of national bankruptcy or financial ruin is remote for the United States...

That's a good bit of perspective, after all.

Graphic Credit: Matthew Yglesias