Today Bruce Bartlett explains (in Forbes) that Republicans just don’t get it when it comes to fiscal stimulus–that when it comes to effective countercyclical policy, bigger deficits are better:
One reason why Republicans strenuously oppose the Obama administration’s fiscal stimulus plan is because it repeats the errors of Franklin D. Roosevelt. To them, the New Deal was mainly about vastly expanding government spending and deficits, which Republicans believe made the Great Depression worse rather than better. Therefore, doing so again in the present downturn will also lead to failure…
But in terms of fiscal policy, Roosevelt’s error wasn’t that he spent too much, but that he didn’t spend nearly enough…
The critics [of the New Deal] were also totally opposed to deficit spending. As with Republicans today, they said that federal borrowing would simply draw funds out of productive uses in the private sector to be squandered on make-work government jobs, pork barrel projects of dubious value and welfare programs that would sap the dynamism of the American economy.
Apparently, it didn’t occur to these critics that the existence of vast unemployment, closed factories, abandoned farms and extremely low interest rates meant that much of the private sector’s resources were simply idle. Borrowing them by running deficits didn’t reduce private output because there were no alternative uses available.
Furthermore, an expansive fiscal policy was essential to recovery because without it monetary policy was impotent and deflationary conditions continued…
Bruce then looks back at the historical data on GDP during the New Deal era and calculates what the “appropriate deficits” would have been, in contrast to what the actual deficits were; as he explains (my emphasis added):
In the table below, I have done a very simple calculation showing what fiscal policy should have been during the New Deal. I assume that the economy’s real productive capacity was at least equal to what it was in 1929 throughout the 1930s. The difference between the actual gross domestic product and what it was in 1929 I assume to be the output gap–a measure of idle resources.
Then I show the federal budget surplus or deficit and a calculation of how much the deficit should have been to compensate for lost gross domestic product. This required making an assumption about the multiplier effect–the number of times federal spending turns over as workers hired by government programs spend their earnings, thereby creating income and employment for other workers and so on…
Bruce’s table shows that deficits should have been maybe ten times larger than they were in the early 1930s, to close up that GDP gap. My question is whether that’s really the “appropriately sized” deficit, and “appropriate” for what purpose? For that fully compensates for lost GDP during the downturn (is full compensation, or a complete “filling up” of the economic hole, necessary or even desirable?), and it won’t necessarily even increase GDP in the longer term, once the adverse effect of higher debt (lower national saving) is accounted for. (The Congressional Budget Office warns of the recovery package’s potential net adverse effect on GDP by as soon as five years from now.)
And Bruce explains why it took World War II to bring us out of the depression:
Ironically, Republicans implicitly acknowledge the truth of this when they argue that “the only thing that brought us out of the depression was World War II,” as Sen. John Ensign explained on Feb. 7.
Yet Republicans conveniently overlook the fact that it was massively larger budget deficits–which averaged close to 20% of GDP from 1941 to 1945–that were the principal contribution of the war to economic recovery.
But I have to wonder, without the convenient spending demands of a major world war (and this is not a reason to wish for war), can we come up with enough quality deficit-financed government spending to both effectively fill a lot of our current economic hole (reducing the output gap) in the short term and be “worth it” in terms of providing a net positive for our society (whether measured in GDP or broader notions of social welfare) over the longer term?
I still think that when we ask whether a massive amount of deficit spending makes us better off or not, it’s also the quality, not just the quantity, of the deficit spending that matters. It’s still a question of whether the benefits are worth the costs.