Budgeting for RecoveryThe need to increase the federal deficit to revise a weak economy

Published 6 January 2010

Written by Josh Bivens of the Economic Policy Institute

Presented by Engr. Hasan AlSayeghSpecial Topics in Economic Policy14 November 2011Dr. Nayef Al-Shammari

Introduction (US Economy)

Eight (8) million jobs lost since Dec. 2007

Unemployment highest in 26 years

Recession over but profound weakness in job market

View point that “federal deficit is harmful to economy and

must be avoided” is prevalent, which is wrong

“When workers and plants are idle and offices are empty,

and when investment funds are begging to be borrowed,

this is the time of deficits.”

“The obstacle for strong action on creating jobs posed by

deficits is strictly political, not economic.”

Paper examines relationship between:

Federal deficits, Interest rates, Inflation, International indebtedness, Generational equity

When there are idle resources in labor & capital markets, and interest rates at or near zero:

NONE of negative outcomes feared from running larger deficits will happen

Biggest threat is deficit will not be big enough for economy

American Recovery & Reinvestment Act (ARRA – 2009)

Small impact on overall budget deficit; short & long term

Long-run deficit impacted by Medicare, Medicaid

Need to reform for long-run budget balance

Past year & half: no reliance from US foreigners to finance government deficit

Private domestic savings increased faster than gov’t. borrowing: domestic residents holding public debt

US Budget Deficit Defined

Deficit occurs when federal government spending is greater than revenue in a given year

To finance deficit, gov’t. borrows by selling bonds

US federal spending dominated by social security, Medicare & Medicaid, defense spending, interest on debt

All other spending accounts for 15% of overall budget!

US federal revenue: federal income taxes, social insurance taxes, payroll taxes

Causes of Current Deficits Q: How much of deficits (total debt) are due to policies of

the Obama administration?

A: Very little

Changes to budget occur from

1) Policy changes

2) Changes in economic conditions

Cites work by Auerbach and Gale (2009), and Irons, Edwards, and Turner (2009), resulting in:

Most of deterioration in budget balance between 2001 and 2008 due to policy changes by Bush administration, not economic conditions

In 2009, deterioration of economy explains large increase in deficit for 2009

Economic Expansion of 2001-07

CBO forecast in 2001: federal budget balance improve by ~$300 billion per year between 2001 and 2007; surplus to be ~$573 billion in 2007

Instead, budget was always in deficit; 2007: $161 billion

Represented $736 billion decline relative to original forecast

Decline explained by policy changes, not slow econ. growth:

Tax cuts; explain half of policy-driven declines in budget bal.

Increased defense and security spending (incl. Iraq, Afghanistan)

New Medicare prescription drug benefit (created with no revenue source)

2008: First Year of Recession

$71 billion of $298 billion increase in deficit was attributed to overall economic weakness

By end of 2008, the difference between actual deficit and CBO 2001 projection was $1,091 billion

2009: Economy Implodes Between January 2008 and

August 2009, baseline CBO deficit projection increased by $1,380 billion $778 billion from changing

economic conditions

Less than a third of remaining $600 billion due to ARRA exp

Remember: $2.3 trillion difference between the large surplus projected in 2001 by the CBO for 2009 and the large deficit for 2009 is still mostly a function of policy changes instituted over that time period They contributed $1.4 trillion

to this change

Role of Recovery Act in Rising Deficits

Rise in deficit in 2009 caused by ARRA ($181 billion) less than 25% of decline caused by worsening economy

Thus, in near term, people concerned with large deficits should support policies to boost ailing economy to:

Reduce mechanical loss of tax revenue

Limit rise in safety net spending

Recovery Act designed to wind down quickly after 2011

Not an issue over the long-run deficit

Impact of Bailouts on Budget, Deficit

Rescue by government of insured and non-insured financial institutions, support for automakers, affect the budget, deficit, debt in complicated ways

Troubled Assets Relief Program (TARP): $700 billion

CBO expects most to be repaid, remainder calculated as part of deficit

BUT, full gross cost of TARP interventions is calculated in public debt

Nationalization of Fannie Mae, Freddie Mac adds more to annual deficit than to national debt

Government issued no new debt to acquire them

Declared them insolvent, put them into conservatorship

Cost of guaranteeing liabilities of bonds adds to deficit

Impact of Bailouts on Budget, Deficit

Bailouts have provided valuable subsidies to those receiving them

CBO estimates over a third of TARP will be pure subsidy to financial institutions, added significantly to short-term budget deficit

Benefits to economy are less clear than benefits by Recovery Act

But, these interventions not expected to be ongoing

Little impact on the long-run budget

Source: CBO – November 2011 Monthly Budget Review