Tuesday, July 21, 2009

Deficits saved the world

From Nobel Prize winning economist Paul Krugman's blog Conscience of a Liberal:

What we’ve had is a sharp increase in the desired private surplus at any given level of GDP, due to a combination of higher personal saving and reduced investment demand. This is shown as an upward shift in the private-surplus curve.

In the 1930s the public sector was very small. As a result, GDP basically had to shrink enough to keep the private-sector surplus equal to zero; hence the fall in GDP labeled “Great Depression”.

This time around, the fall in GDP didn’t have to be as large, because falling GDP led to rising deficits, which absorbed some of the rise in the private surplus. Hence the smaller fall in GDP labeled “Great Recession.”

What Hatzius is saying is that the initial shock — the surge in desired private surplus — was if anything larger this time than it was in the 1930s. This says that absent the absorbing role of budget deficits, we would have had a full Great Depression experience. What we’re actually having is awful, but not that awful — and it’s all because of the rise in deficits. Deficits, in other words, saved the world.

More here, complete with an economics curve chart!

In short, private spending plus public spending equals the gross domestic product, or if you prefer, the US economy. When private spending tanks, as it has recently, the economy goes down with it, unless public spending picks up the slack, which is what's happening right now with President Obama's stimulus spending. And what Krugman is asserting is that private spending has tanked so much that if we hadn't increased government spending the way we have, things would be MUCH worse than they are right now.

Of course, there's that nasty deficit spending we've all been worried about for the last three decades or so.

Look, I worry about deficits, too. When you have the government taking the lion's share of the money supply out of the economy, which is what happens with massive deficit spending, it necessarily means that there is less money available for private investment, which slows the economy, eventually taking it into recession. That's bad.

But we must keep things in perspective. The kind of recession resulting from massive deficits happens slowly and gradually. The kind of recession we're actually enduring at the moment happened very quickly, with the potential, absent Obama's stimulus, to be far far worse than deficit spawned recession. Screaming "Deficit! Deficit!" right now is like bitching at the fire department for getting the furniture wet while your house burns down around it.

Deficits are a problem. But one we'll have to deal with later, when the economy is in better shape, and able to produce more tax revenue. Until then, whining about deficit spending in the abstract is something of an academic argument doing nothing but distracting us from the work at hand.

It really is as though most of the prominent voices in the public discourse on these issues know virtually nothing of economics or history.