Some Simple Deficit Reduction Arithmetic

Kash Mansouri in The Street Light explains Some Simple Deficit Reduction Arithmetic from Macro 101 that even I can understand.

"Suppose that the country – let’s call it Austerityland – has a GDP of $100/year, and a budget deficit of $10/yr, or 10% of GDP. And suppose that the government decides it wants to get the deficit down to 5% of GDP. How can it get there? No, the answer is not “cut spending by $5/yr”. Nor is it “raise taxes by $5/yr”. And last but not least, it is also not “enact a combination of tax increases and spending cuts that total $5/yr”. To see why, let’s do just a bit of arithmetic."

He goes on to show how cutting government spending by $5/yr results in a new deficit of $6.875, which is 7.4% of the new level of GDP and that to get to 5% deficit of GDP you need a $9/yr cut which lowers GDP by 14%!

He points to recent UK and Greek austerity measures which are failing. "When basic Macro 101 both makes good theoretical sense and also fits what we actually observe, it's really time to start looking for your handy Occam's Razor."

He followed up Comparing Two Approaches Toward Deficit Reduction by showing how growing the economy works better.

But as Krugman points out, the chicago school of economics can't even conceive of Keynesian economics. Mark Thoma points out others and talks about repeating the mistakes of 1937.

Robert Reich in The Truth About the American Economy explains that the problem. "The problem isn’t on the supply side of the ledger. Corporate profits are still healthy. Big companies continue to sit on a cash hoard. Large and middle-sized companies can easily borrow more, at low rates. The problem is on the demand side. American consumers, who constitute 70 percent of the total economy, can’t and won’t buy enough to get it moving. They justifiably worry they won’t be able to pay their bills or afford to send their children to college or to retire."

He also gives plenty of examples of things the government could do to help if not for the paralysis of Washington.

Jared Bernstein sends a Note to Congress: Stop Screwing Around and Raise the Debt Ceiling. The deficit is so high in part because the labor economy is so bad. "Falling employment rates, or rising unemployment, are associated with larger budget deficits. One begets the other as safety net programs and other measures to offset the contraction ramp up, and as tax revenues, whacked by the downturn, fall. We don’t have a tough economy because of current budget deficits. To the contrary, our economy is markedly better off because public spending temporarily expanded to partially offset the massive private sector contraction."

"So stop blaming Obama and spending and the French and socialism and Keynes and the liberal media… and stop screwing around and get your act together and do the right thing. Raise the debt limit and get back to work."