Tuesday, August 23, 2011

A Better Analogy for the Deficit?

The recurrent "government should balance its budget like a household" trope has been one of the more infuriating aspects of recent debates over economic policy.  Its easy to see the appeal for politicians who want to appear to be talking "common sense," but the policy implications are destructive.  In the LA Times, I suggest a different analogy:
Politicians of both parties have furthered the misunderstanding by frequently drawing an analogy between the federal budget and household budgets. "Families across this country understand what it takes to manage a budget," President Obama declared in a February radio broadcast. "Well, it's time Washington acted as responsibly as our families do." While this comparison appeals to a general belief that we should "live within our means," it's also misleading.

Decisions about the federal budget are fundamentally different from those of individual households, because policymakers need to account for how their choices affect the economy as a whole. It is more appropriate to liken government budget deficits to prescription medicine. Just as medication can be helpful to a sick patient, deficits can aid a failing economy.
The debt ceiling debate showed how hard it is for the political system to deal with something that can be good in some circumstances, bad in others.  I hope this is a way of thinking of it that is simple and intuitive, but also right.

Of course, the ideal is to simultaneously have an expansionary policy now, but also a plan for a (roughly) balanced budget in the long run (i.e., after the economy has returned to health).  But the debt ceiling fight illustrated how raising the issue of long term projected imbalances starts a big fight over the ultimate size of government (which isn't what countercyclical policy is about).  With 14 million people unemployed - and interest rates very low - that is a dangerous distraction.

10 comments:

The Arthurian said...

Nice (you got published). I like the way you bring the medicine analogy back, near the end of the article. But... they didn't link to your blog!!!

A question on your post here: When?

You say we should plan for a roughly balanced budget in the long run. Keynes said in the long run we are all dead.

I have seen a similar argument from Krugman, take care of the crisis now, deal with deficits later. I think people don't buy that argument because we couldn't deal with deficits even *before* the crisis.

Maybe my question is not When will budgets be in balance, but How? Since even when the economy was good we couldn't balance them.

Or, what is the benchmark for economic health? the late 1990s? the 1980s?

CenterforProgressiveEconomics said...

I read your article in the LA Times. It was well written and correct. But is misses the entire point, cause and solution to the Great Recession. The United States is a monetary sovereign nation. It does not have to create and distribute new money through debt. This "debt money" creation system mainly by the commerical banks is to narrow and monopolistic to effectively create and distribute new money into a 21st Century economy!
The answers and research are at www.progressive-economics.com and www.monetary.org of the American Monetary Institute. We are not even debating the substantial improvement of the monetary system. Let it start!!

Mark Pash, CFP
Center for Progressive Economics

Allan said...

What, next you'll tell me that the fact that my living room has a flat floor doen't prove that the Earth is flat! It's just common sense.

Bill C said...

Thanks.

Yes, "long run" is pretty vague. I'll take late '90s as a benchmark for a "good" economy (though certainly we could think of ways in which it was flawed). If you look at CBO "current law" projections which go out 10 years, the deficit basically stabilizes around 2% of GDP in 2014, which is low enough to get the debt-GDP ratio falling (i.e., small deficits are ok - nothing magic about being at zero). That assumes Bush tax cuts expire as scheduled; if not deficits are more like 4-5% of GDP, and debt-GDP ratio continues to rise. Much longer term, medicare costs are a big problem, but this is a function of health care costs rising faster than overall GDP - i.e., its a health care system problem. So you could basically "solve" the problem over the next 10 years by letting the Bush tax cuts expire. Longer term need to "fix" the health care system - "Obamacare" deserves credit for moving in the right direction on this, though not far enough. I'm ok with reverting to Clinton era taxation. But obviously some people really aren't, and I definitely don't think that's an urgent debate to have now.

It is true that I didn't touch monetary policy, but, given how paralyzed fiscal policy, its really about the only game in town (sigh...).

I find countercyclical policy to be pretty commonsensical, but obviously many don't (or choose not to).... It is frustrating that the basic idea seems not to have sunk in.

BTW, I think LA Times did add a link to the blog; it was nice of them to plug it for me.

Anonymous said...

Thank you.

Some freakin sanity for once.

DanF

Anonymous said...

"Of course, the ideal is to simultaneously have an expansionary policy now, but also a plan for a (roughly) balanced budget in the long run (i.e., after the economy has returned to health)."

The ideal budget is the one consistent with low unemployment and inflation. That's the ideal budget today AND tomorrow. And it would be freakish coincidence if this ideal corresponded with a balanced budget.

Saying that the budget needs to be balanced in the long run (unsaid but implied: even if doing so damages the economy), besides being wrong, undermines the case for deficits now, since deficits move us at least temporarily farther away from this alleged ideal. It all feeds into conservative fears about national bankruptcy, hyperinflation, etc.

Benedict@Large said...

When the federal government borrows money, this money comes from aggregate bank reserves. If it borrows a lot of money, you call it "crowding out", and say that this lifts rates. Not really.

The federal government does borrow from aggregate reserves, but spends the borrowed money right back into them (minus a trivial lag time). The only time when this wouldn't happen would be when the federal government was running a surplus.

Since the federal government isn't running a surplus now, and since aggregate reserves are not lowered by federal borrowing because the borrowed funds are replaced by spent funds, where is this crowding out occuring, and lacking it, how do interest rates rise from federal borrowing?

Gotta watch your bookkeeping there. Money DOESN'T just disappear when the federal government gets it, no matter how much the right wing wackos want us to believe that.

Adam said...

The only way to balance the budget is to increase exports and increase private sector debt so why do we want to even try to do that when those things won't make us more prosperous.

William Waller said...

A very nice column.

Anonymous said...

"Households" is in fact an appropriate government budget analogy, within limits. Of course households cannot print money, their budgets and income are miniscule compared to that of governments, and they MUST limit their spending commensurate with their income and assets. But it is foolhardy and immoral to promote the idea that governments can -without limit- spend their way out of deficits, or pile up enormous unfunded liabilities as our federal government has done over the recent past -especially the past five years or so. Our unfunded liability for entitlements is over $ 114 trillion. Our debt has risen to risky high percents of our GDP.

You say, "policymakers need to account for how their choices affect the economy as a whole". Yes, they should, but they do not! They are fiscally, policy-like, and morally irresponsible.
It is widely understood that the medicine we need is jobs.

Yes, the medicine is jobs. But businesses -not governments- that hire people are faced with too much uncertainty about real and perceived federal nanny state control, regulation and taxation. Just ONE example of federal government over-control and bureaucracy: the NLRB. The NLRB is suing Boeing for trying to hire people in S. Carolina -a right to work state-; over 1000 jobs are at stake. The NLRB just issued an "edict" that business (all?/most?) must post a notice about union benefits. The NLRB is proposing new rules to, e.g., require companies to turn over every worker's address,. phone number, and email address to union operatives.

Three free trade agreements (Colombia, Panama, South Korea) were inherited by this Administration. Other countries have entered into agreements with these countries, so that U.S. exporters are at a disadvantage. Why the delays How many new hires could there have been?

The federal government is way too large. We need limited government, not more. More bureaucrats publish more and more regulations -they are way out of control. The federal register is causing our forests to be depleted.

Congress has not passed a budget for over two years. President Obama's last budget was voted down 97-0 in the Senate. The CBO stated that it would increase the deficit by $2.7 trillion over the next decade. S&P warned that unless about a $4 trillion cut in spending was achieved -or even promised- they would downgrade U.S. credit. Well, to their "credit", they did it. When will our elected officials see the "light of day"?

"The problem with Socialism is that eventually you run out of other people's money" Margaret Thatcher.