Re: Budget deficits and GDP

On Tue, 27 Nov 2007 22:14:48 -0800, Lysander wrote:

On Nov 26, 10:18 pm, dekka <eddiepy...@xxxxxxxxx> wrote:
Hope this is the right board:

Could someone with an economics degree explain to me academically how
a budget deficit hurts the economy(especially GDP)? I've taken a few
international economics courses, so
feel free to get technical.

Thanks!

The following stuff from lysander is (surprisingly) somewhat correct. I
am shocked.

There are differing effects of budget deficits in the short and long
run. For the short run I will give you the theory then some potential
problems with the traditional theory. At least since Keynes, Economics
has shown that budget deficits are a useful tool at fighting
unemployment. The traditional Keynesian view is that due to
imperfections in the labor market, mainly nominal wages being sticky
downward, the cost of living effects employment. This means pure price
effects such as inflation and deflation have real effects on output.

The traditional view is that recessions are caused due to Aggregate
demand shocks. These can be from people deciding to spend less, the
marginal propensity to consume dropping, or due to expectations
causing less investment in the economy. Demand for investment goods
are part of Aggregate demand. Foreign exchange rates can affect AD as
well as exports add to aggregate demand and imports decrease demand.

(not bad... not actually correct, but not terribly wrong either)

In a demand side recession, that is AD decreases, the appropriate
policy is to increase demand to where it was before. This can be done
with monetary policy or tax and spend.

Actually, the Keynesian position is that monetary stimulus (dropping
interest rates) has little effect. Absent the government spending to
increase AD, no one is going to borrow money to invest. It is like
"pushing on a string".

If using tax and spend you want
to create a deficit.

It is spend only that effects demand. The tax part may or may not serve
well depending on how the taxes are assessed and collected.

You increase government expenditures which in
turn pays people who buy goods which pay more people who buy goods. As
the dollars continually turn over consumption also increases and
raises AD. You can cut taxes as well which gives people more take home
pay so consumption rises.

True..... If you cut taxes on the low and moderate incomes then
consumption (demand) will rise. This does not hold true if you cut
taxes on the high incomes.

In an inflationary period you would want to cut deficits and run
surpluses. This deficits make inflation worse. The traditional
Keynesian view is run surpluses during inflation to pay for deficits
in recession so the budget is balanced over the cycle.

Tax collections are a direct cure for inflation in that money is removed
from the economy just as it would be if the Fed raised interest rates
and/or Treasury started selling bonds like crazy. The difference is
that appropriate taxation need not curtail investment. The increased tax
collections must be in the middle income range as opposed to the high
range to achieve the opposite effect of the tax cuts that would have
stimulated consumption.

The problem comes from how deficits are financed. In order to finance
a deficit, the government must issue bonds. People buy these bonds and
the government uses the loaned money to make up the difference between
taxes and expenditures. The Fed may also buy bonds if they wish to
increase the money supply.

This is where the effect of deficits becomes questionable and
potentially harmful to the long-run. There should be exist equal
returns, adjusted for risk among assets, this means all assets are
equal attractive in equilibrium. As the government issues bond, the
supply of bonds rises. The price of bonds fall as the government
"floods the market" with debt instruments. This causes the yield on
bonds, the interest rate, to rise. The yield on a bond is a function
of the price when the bond cost less you get a higher yield. The rise
in interest rates filters into other markets as the interest rates
must rise to be competitive. The result is higher interest rates and
less investment. The drop in investment causes the increase in
consumption to be offset.

This is harmful in the long run because investment in new capital is
part of the engine of economic growth. High interest rates cause less
capital to be bought and can slow down the rate of growth for the
nation.

The other harm comes if the Fed wants to target a certain interest
rate. As the interest rates rise the Fed must expand the money supply
to keep interest rates at the current rate. This is called monetizing
the debt. The Fed goes in and buys bonds to offset the increase in
supply. The interest rate is not affected and crowding out does not
happen. This is why detailed analysis is necessary to show crowding
out. If one only looks at the correlation between interest rates and
deficits they may not see the effect because the Fed's action cancel
out the interest rate effect. You have to control for money supply
changes before the data show the result. Anyway, the problem is the
increase in the money supply may increase AD more and cause
inflation.

Deficits have an inflationary component that is made worse when the
debt is monetized to keep interest rates low.

The good effect from deficits is less unemployment, if u/e is above
the natural rate.

The bad effects are more inflation and decreased economic growth.

Time for the major intrusion on this theoretical stuff: Increased
government spending is what stimulates the economy --- NOT DEFICITS. It is
entirely possible to increase government spending AND TAXES so as to spend
more and actually _cause_ more consumption and investment without ever
having a deficit. The latter day neoconomist assumes that government must
increase or decrease taxes across the board as opposed to varying what or
who is taxed. Keynes seems to have made the same silly assumption. In
addition Keynes assumed that money was gold and that borrowing and
taxation were the only mechanisms by which spending could be financed. It
is as thought the notion of monetization never did intrude on Keynes. We
buried the gold standard but the Republicans don't seem to be able to
BENEFICIALLY use what that created. The same neoconomists that would have
us believe that all taxes are equivalent would also have us believe that
all government spending is equally stimulative and equally problematic in
the long run. And none of these assumptions should ever be valid unless
you have totally brain dead Republicans advised by neoclassical economists
from Cato running the government.

There is also the public choice case that argue that deficits are bad
because uncontrolled spending gives lobbyist too much power. The
average voter has little information and little influence. The lobby
can use its influence to seek rents and get spending. Allowing any
level of deficit allows lobbyist free reign. By requiring balance
budgets lobbyist influence is much more limited. There is a limited
amount of funds to fight for and lobbyist must compete which lowers
their power.

If you tax the hell out of rent then there will be a lot less rent
seeking. But I admit there will be a lot of lobbyists seeking to convince
government to not tax rent. And they will be paying lots of money to the
Cato institute also.

There are some papers out now that are indicating the doctrine of
starve the beast does not work.

Now???? Most rational people knew that was total crap in 1982.

That is cut taxes and not give
government enough money to expand. They do that anyway. One member of
CATO has noted that divided government is the best tool to fight
spending.

Well certainly! Government spending (except for spending on imperialism
and occupations of other nations of course) is the Wicked Witch of the
North. Especially if it is spending on infrastructure or general
welfare.

When the party in the white house differs from the party
that controls congress spending is limited the most. This holds at
least back to Eisenhower. When the Republicans took over under Clinton
spending dropped. When the Democrats slightly took over the Senate
under Bush spending dropped. It lead to the comment "as a conservative
I hope for divided government, I do not care as to the way it comes
about." Meaning it doesn't matter if a democrat is President and
Republicans control the legislature or a Republican is president and
the Democrats control the legislature. The result is likely a lot less
spending.

What actually matters, of course, is the beneficial or harmful nature of
the spending. The CATO people and those who fund and who listen to CATO
do not want ANY government at all. And they will do all they can to make
damned sure that government cannot to do anything worthwhile.

--
"I know no safe depository of the ultimate powers
of society but the people themselves; and
if we think them not enlightened enough to
exercise their control with a wholesome
discretion, the remedy is not to take it from
them, but to inform their discretion by
education." - Thomas Jefferson
http://GreaterVoice.org/extend

.

Relevant Pages

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