Deficits are Totally Normal and Probably Good

It is often taken for granted that a national government spending more than it takes in in revenue is a bad thing. Even those who do advocate for spending often present it as “countercyclical”. The suggestion is that it is permissible to counteract the boom bust cycle – with spending-above-receipts during the bust meant implicitly (or explicitly) to be compensated for by spending-below-receipts during the boom.

However OECD data shows that deficit spending by governments is not just cyclical, but consistent, normal behaviour, at least for most nations with large economies.

Across multiple business cycles and across the OECD (both overall and in a majority of nations) as well as in large economies which are not OECD countries (but for which the OECD has data), deficit spending overwhelmingly prevails.

If governments are getting it wrong, they are doing so with remarkable consistency.

The value for each country is the average of all the years for which the OECD dataset had values for that country

The data shows that overall, OECD governments cumulatively spent more than they recieved in taxes every year going back to 1991, which is when the dataset starts.

Contractions in this cumulative defecit spending occur before US recessions, with expansions afterwards. This indicates that defecit spending functions to alleviate economic crises, rather than cause them.

For some OECD countries, such as Finland, Italy, Japan, Sweden and the United States, the data set has values going back as far as 1960. The following graph combines those, paying no attention to the size of national economies, thereby favouring small net-surplus nations like Finland and Sweden. This distortion is compounded by the fact that two thirds of all the net-surplus countries in the entire data set were already overrepresented in this longer range data compared to net-deficit countries, less than one tenth of which are present.

Yet not only we find that more nations ran deficits than surpluses overall, but that the surpluses were also smaller as a proportion of their national economies than the deficits, overwhelming the bias in favour of these two exceptional countries.

If deficit spending is as dangerous and damaging as it is made out to be, where are all the consequences? If balancing the budget over the medium to long term is, as it is often presented, a technical neccesity, rather than a policy choice, when do we run out of road?

Two possible responses to this from the deficit hawk perspective are:

  1. We have suffered and are suffering the consequences of this overspending now and had the government taken its austerity medicine, things would be better than they are. Countercyclical spending is bad, and harsher economic contractions would, in the long run have been a good thing as they would have forced marginal businesses to close, freeing up resources for more productive enterprises. Proponents of this laissez-faire approach however, might have a hard time convincing policy makers that such an approach wouldn’t just lead to a catastrophic deflationary spiral like the great depression where noone has any money to buy the products and services of these more efficient businesses, causing them to fail, too, leading to more unemployment, and creating ever greater shortfalls in spending power.
  2. The consequences are still coming, often in the form of inflationary chickens coming home to roost. A version of this is the predictions of hyperinflation (often branded #Bidenflation) as a result of allegedly excessive pandemic spending – putting too much money in the hands of consumers, especially free money, which would disincentivise productive work, contracting supply precisely as it increased demand. This is actually the strongest argument the deficit hawks have had in a while, as there have been significant increases in US inflation over the last few months, it is often pointed out these are the highest in decades. But focussing on that ignores the deflationary conditions that have prevailed throughout those decades. One article taking this editorial line used the following graph of total retail spending:
original chart from wolfstreet.com

However if we add a line starting at the first data point and ending at the last one, we see the US is only just now approaching the level of retail spending it would have reached had it had maintained its pre-crisis trend, from the years 2004-2007, when US inflation was at moderate levels, rather than the historic lows it has seen since.

modified image

What the data suggests to me is not that Biden is spending too much, but that the last two presidents, at least, were not spending enough. And the inflation we did see, it turns out, is already cooling off.

If anything, Biden should go harder.

My evidence for this position is the fact that central banks around the world, inlcuding the all important US Federal Reserve, are keeping interest rates at or near zero – a historically inflationary setting. If the economy showed any signs of runaway inflation, these banks could and would, in line with their technocratic mandates, increase interest rates. The fact they have not – indeed can not, despite concerns about cheap rates causing rapidly rising housing prices in many countries – implies we still face strong deflationary headwinds, which government spending, so far, has not made a significant dent in. As does a glance at this long term inflation data from macrotrends:

This is particularly important if you take the view taken by some, including proponents of Modern Monetary Theory, that the government can’t run out of money any more than a sports arena can run out of points. Government issues units of currency they way the umpire issues points, out of nothing. Taxes, in this view, are best understood as money destruction, used to help control inflation, which is the real constraint on spending. The government might not run out of money, but it can run out of things to spend it on. So there is a limit to government spending, it’s just not set by tax receipts, but rather by the productive capacity of the economy. You know when you’re approaching it not just because inflation rises, but because modest increases to interest rates become less effective at controlling that inflation. Currently interest rates are being used in the opposite manner, working overtime to just prevent deflation.

Our obsession with balanced budgets, in this view, is called “the household fallacy”, since it imagines a government is like an ordinary household, which must limit its spending to match its income or face bankruptcy. Some argue (I believe correctly) that this fallacy and its prominent repetition in the media, causes governments to habitually underspend. This not only means leaving productive capacity idle while people go pointlessly without, it means an overreliance on private debt to fuel economic activity and a general economic malaise where what growth we do have is captured by those at the top.

In this view we are already suffering the consequences of this underspend in the form of lost growth over the previous decades, not to mention the inherent good of the hospitals, roads, schools, income support and so on, which such government largesse could have provided.

Comments

  1. Great work Austin

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