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Great News!

So my earlier post about worldwide bankruptcy was apparently alarmist. Obama has just assured us that he plans to cut the budget deficit to only $550 billion by the end of his first term. Well, that's just lovely news.

Never mind that that number is still higher than any budget deficit until this year's, which should run around $2 trillion. Assuming an arithmetic rate of reduction, that means that Obama will only leave us about $4.5 trillion deeper in debt than when he started, by the end of his first term. Even Bush was only able to do about $1.1 trillion of damage in his first term.


Those deficits--stated in absolute dollar amounts--are huge. But it's also true that the size of the US economy is huge.

It is more meaningful to talk about deficits in terms relative to the size of the economy. Expressed as a percentage of GDP, the Congressional Budget Office estimates that this year's deficit will run to about 14%* of GDP, as you can see in this chart:

While this is still super-high, it's not unprecedented. Between the years 1942-1945, the government ran deficits of 14.2, 30.3, 22.7, and 21.5% of GDP, respectively:

So, yes, in absolute terms this is by far the biggest deficit ever; but in properly normalized terms, it's the biggest deficit since WWII. But of course, all this spending is not (according to Obama) a bug, it's a feature--it is, in fact, the point: it's precisely this extra spending that is supposed to increase overall demand so that we avoid a Great Depression-style "deflationary spiral", which is a scenario that would result in even more shrinkage of GDP, more unemployment, and more federal debt.

Moreover, if we could get back down to a deficit of $550b by the end of his first term, we would be back in "normal" deficit territory, with a deficit of around 3-4% GDP. In a recovering economy with a war going on, that's not *too* bad.

Of course, you still have all those deficits accumulating and increasing the debt, but, again, while high the debt as a percentage of GDP has got *some* room to maneuver before it hits the WWII mark and goes into unprecedented territory:

I suppose the real bottom-line question to ask is: do you think that the federal government ought to engage in counter-cyclical spending during bad recessions, or do you think federal debt is just always bad and the federal government should cut back spending in a recession? Most stimulus critics base their criticism on empirical skepticism that the spending will have a sufficiently stimulative effect on the economy, but your skepticism seems to just be an aversion to deficit spending.

Or is it that you think investors will stop financing US debt?

*That 14% number is kind of dubious, because it includes the TARP money, which is really more government investment than spending--the government will eventually sell those assets and make some of its money back (but will almost certainly take a big loss). So if you want to say the deficit is 14% here rather than 8%, you must also mentally factor in an X% boost later on when those assets are sold.

February 25, 2009 at 8:10 AM  

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