In a recent Forbes article, John T. Harvey, a Professor of Economics at Texas Christian University, argues that we should love the deficit, not hate it. The reason we hate the deficit, says Harvey, is that we have come to believe some myths about deficits and government spending that Republicans and Tea Party lovers constantly promote. Here are a few examples of the myths and the truth according to Harvey:
Myth: Cutting the deficit by reducing spending puts money in my pocket.
Harvey: This ignores the fact that a) you weren’t being taxed to finance the deficit in the first place (or it wouldn’t have been a deficit) and b) government spending is money in someone’s pocket. Thus, cutting the deficit by reducing spending removes money. This is true even if you are in the private sector, since those government employees bought groceries, paid rent, went to the mall, etc., etc. They earned income for you by buying what you sell.
Myth: You can’t spend your way out of a recession.
Harvey: Of course you can. We did it in the Great Depression, Reagan did it, and it’s what we should be doing right now (instead of bailing out the financial industry, wasting time with Quantitative Easing, and trying to balance the budget). [Understanding why deficit spending works] requires knowing a little something about the macroeconomy. Most critical is the fact that the private sector is incapable of consistently generating sufficient demand to hire all those willing to work. This is in spite of being able to produce enough output for everyone to enjoy–in fact, it’s partly because of it. A detailed explanation is offered in this post, Why Recessions Happen, but for here suffice it to say that if 90 people can produce a sufficient volume of goods and services to satisfy 100 people, then why would the private sector hire all 100? It wouldn’t, and those without jobs must go without the output that we are nevertheless able to produce for them. The unemployed lack the income that would make the production of those extra goods and services profitable.
This is where the government can play a useful, indeed vital, role. They can supplement demand by employing the unemployed as soldiers, sailors, airmen, marines, teachers, firemen, police officers, etc. Because we started at a point of less-than-full capacity, private sector workers give up nothing, entrepreneurs earn extra profits, and it creates a series of non-market services (national defense, fire protection, education, etc.). It is truly a win-win situation, which is possible when we have idle resources. And the funds to finance these activities should come from deficit spending. There is no point in taxing away spending power from the private sector in order to create demand from the government. That’s self-defeating.
So, yes, you can spend your way out of a recession because a recession is caused by lack of spending.
Myth--Cutting government spending frees up resources for the private sector to grow.
Harvey: It might do so if we were already at full employment and using all our productive capacity. However, in the midst of the worst recession since the Great Depression, this argument holds no water whatsoever. We have plenty of idle resources; the private sector is simply choosing not to employ them. There is no need to free up something that is already in excess supply. Nor is there some web of regulations and taxes that is preventing recovery. The past thirty years has been a continuous deregulation of our economy and effective tax rates [are] as a low as they have been since before World War Two.
Myth--The debt has never been this large.
Harvey: The proper measure of the size of the debt is relative to the size of the economy. Gross Domestic Product is typically used as the gauge of the latter. Even the most extreme measures of where it stands today puts debt/GDP at less than 100%. It reached its peak during WWII, when it was around 120% of GDP. The 1950s were , incidentally, hardly a period of economic Armageddon.
Myth--We have largest debt in the world.
Harvey: According to the CIA Factbook, as of 2010 we ranked 37th. That put us behind the world average, Spain, The Netherlands, Austria, the UK, Israel, Germany, Portugal, France, Ireland, Belgium, and Japan.
Myth--The debt must be repaid
Harvey: We must, of course, meet the “monthly payments,” but the level of debt need never be zero. The government has an infinite life span, so there is no day of reckoning when all debts must be settled. And since the debt is owed in dollars, there is never any question that we have the ability to repay since we are allowed to issue brand new ones at any time. Nor is this necessarily inflationary, as explained in the next fallacy.
Myth--Deficit spending could create inflation.
Harvey: Yes, it could, if we were already at full employment (unemployment around 4%). In that case, the government would be competing for resources in an economy where no excess existed–that might drive up prices. But we are a long, long way from that right now.
Myth--Government surpluses help the economy grow.
Harvey: In fact, surpluses represent a net drain on private-sector income. Think about it: what would happen if the government spent zero but still collected taxes? That’s what a surplus is, an excess of tax revenues over government spending. We would be bleeding wealth from the private sector and giving it to the public sector. Economic growth creates government surpluses (because tax revenues rise and public support spending falls), not the other way around.
Read Harvey’s complete article here: http://blogs.forbes.com/johntharvey/2011/07/02/learn-to-love-the-deficit/
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