The Best and Worst of Spending

Barbara Cook-Snider

ECO203: Principles of Macroeconomics

Instructor: Marlo Chavarria

February 20, 2012

The Best and Worst of Spending I am writing a paper in response to my class, Principles of Macroeconomics, in which we are to speak about the government deficit and what our thoughts are based on research. It’s easy to speak of what and why our deficit is so high, but there are many different opinions of how to fix it. Maybe there is no one certain way this can be done, I, mean to balance the budget without cutting many well deserved programs is a tough nut to crack. Let’s first look at why the budget is so high and what part does all this play in our growth rate that is affecting our economy today. “Sources for economic growth occurs when (1) society acquires more resources or (2) society discovers way of using available resources more efficiently. For economic growth to increase living standards, the rate of growth must exceed the rate of population increase. The economic growth is generally defined as an increase in real GDP per capita” (Case, Fair, Oster, 2009)
“The current economic situation in the United States and most of the world is as precarious as it has been in decades. Despite the current, welcome feeling that we seem to have pulled back from the precipice of out-and-out global economic depression, the trends are negative in far too many areas -- most obviously, in the continued loss of jobs. I should emphasize "seem to have pulled back" in that last sentence, because it is not at all certain that the financial system has recovered sufficiently to support an economic rebound, nor even to withstand the renewed round of home foreclosures and job losses that could well be in the offing.

The Best and Worst of Spending
When the economy is as weak as it is now, strong medicine is necessary. Macroeconomists have known for decades that the economy can be brought out of periods of ill health by having the government spend money when everyone else is pulling back on their own spending. That is not, of course, "Plan A." Everyone would have been much happier if the economy had continued to expand, which would have made stimulative deficit spending unnecessary. We also would have liked it better if monetary policy (lower interest rates) could have reversed the economy's slide, but rates are already as low as they can go. The last resort was to try to expand the economy directly, which is what the stimulus package from this past Spring was all about.
The increase in the deficit in the face of the weakening economy is, in fact, one of the reasons that focusing on the "cash-flow deficit" can be so misleading. It is one thing to say that we are running a deficit of, say, 12% of national income during boom times, but it is quite another to say we are running a deficit of that magnitude during a recession. During a recession, we should expect that the deficit will be temporarily high, for two reasons:
First, when the economy is weak, we collect fewer tax dollars (because so many people have lost their jobs or have seen their incomes fall), and we also have to spend more money on benefits to prevent people from suffering catastrophic and irreversible harm as they try to find new jobs.

The Best and Worst of Spending
Second, the deficit is also higher during a downturn than it would normally be because of the government's attempts to stimulate the economy. More than a quarter of the projected deficits for this year and next, for example, are due to the stimulus bill -- a law that is explicitly a two-year commitment of federal borrowing as an attempt to reverse the slide. If the recession ends, the need for stimulus will end.
These explanations for the temporary rise in annual federal deficits also explain why we should not respond to these deficits by trying to reduce them. Cutting deficits during a downturn not only is the opposite of being stimulative (thus predictably worsening the crisis), but it is also affirmatively counterproductive. That is because (as states like California are demonstrating even as I write this) attempts to balance budgets by cutting spending and raising taxes become a vicious cycle, since budget cuts throw people out of work and discourage businesses from hiring.
To return to the analogy to taking one's medicine, a patient might respond to an illness by saying, "I hate that medicine. I'm just going to buck up and do what I normally do. I'm going to the gym. That will make me feel better." The patient might even feel virtuous about how "tough" he is being. As we know, however, refusing medication and putting added stress on one's body can prevent healing and worsen symptoms. (There is also an analogy here to the spreading of germs in the gym locker room, but I will leave the interdependence of global economies aside for now.)

The Best and Worst of Spending
In other words, even people who really, truly do not think that borrowing is a good long-term strategy should not object to running deficits in the current economic situation. Indeed, the sooner we get out of this recession; the sooner deficits will go down as we move forward.
Some economists, however – and I am among them -- emphasize that it is wrong even to think that the deficit should be reduced to zero during good economic times. We point out that the federal government is always uniquely placed to be able to spend money in ways that improve the long-term performance of the economy, and we conclude that that unique positioning justifies running annual deficits as a matter of sound economic management.
Support for basic research and development, education at all levels, nutrition for children at the critical early stages of physical and mental development, and countless other forms of federal spending constitute "public investment" that enhances the living standards of both current and future Americans. We should try to increase spending on those crucial items, not reduce it.
Notably, this is true even if the money to fund these government programs is borrowed. (This is exactly the way businesses treat their investment spending, by the way, borrowing money to pay for those items that promise to have long-term payoffs.) Although there is a financial calculation required that is too involved to discuss here, there is no serious disagreement about the point that a government can improve the lives of its current and future citizens by

The Best and Worst of Spending borrowing money to finance many of the things on which the U.S. federal government actually does spend money. While it is possible to collect sufficient taxes to pay for all of those things up front, doing so is unnecessary, because the benefits that the borrowing will bestow on future citizens exceed the additional debt that they will inherit.
The point, therefore, is that the economy's health can be improved significantly by having the government administer "vitamins" regularly in the form of spending programs that will enhance future growth. Moreover, this future growth can take the form of growth in the quality of life, such as environmental improvements, that might not show up in the economy's measured income but that will certainly be appreciated by people in the immediate and distant futures.
As is true with any medical intervention, of course, there can be too much of a good thing. Given that the current economic stimulus package was reduced in size at the last minute (to accommodate concerns about the increase in the deficit) by cutting spending on decaying schools, however, it is difficult to see how one could argue that the federal government is currently spending too much on educating our young people. The crumbling bridges and roads, and the people becoming sicker because of inadequate health care, are further testament to the fact that we are giving the economy "vitamin shots" that are too small, not too large”( Buchanan,2009).

The Best and Worst of Spending
Does it really matter about the deficit spending and if so why? According to an article from; Stephen Slivinski, 2010, he states as such;” Beginning in the 1960s, however, budget deficits became the norm. At the same time, inflation began to take off. While some worried about this, it wasn’t necessarily at odds with the Keynesian view of deficits. In fact, Keynesians saw inflation as an acceptable cost of the increased output and employment that would come from deficit spending.
What’s missing from this simple story is that monetary policy at the time was becoming progressively looser to support more government spending and that began to fuel the subsequent inflation. “The extent to which monetary policy is used to help balance the government’s budget is the key to determining the effect of budget deficits on inflation,” writes Keith Sill, and economist at the Philadelphia Fed.
Indeed, one of the things that economists generally agree on in relation to budget deficits is that – at least in the U.S. experience- they are not inherently inflationary. Analysis of the history of fiscal and monetary policy from the 1960s to the 1980s has led most economists to argue that the relevant factor during this period was that the Fed began to warm to the idea of “monetizing” the deficit. In essence, that meant that Fed would act to guarantee there was always a market for Treasury debt. The fear of inflationary deficits is most credible today in small developing countries” (Slivinski, 2010).

The Best and Worst of Spending
The two main policies that government uses to affect the economy are (1) Fiscal policy and (2) Monetary policy. When referring to how the Fiscal policy works is basically pretty simple this is how much to tax and how much to spend. The Monetary policy is the Federal Reserve, the nation’s central bank.” The Fed, as it usually called, determines the quantity of money in the economy, which in turns affects the interest rates” (Case, Fair, Oster, 2009).
“Fiscal policy is also used to influence the supply-side performance of the economy. For example, changes in fiscal policy can affect competitive conditions individual markets and industries and change the incentives for people to look for work and for companies to invest and engages in research and development. Government capital spending on transport infrastructure and public sector investment in education and health can also have a direct but unpredictable effect in the long run on the competitiveness and costs of businesses in every industry”(Tutor2U.net,2012). The Monetary policy deals with how much and how easy it is get money in the economy. Whether loans should be easily obtainable or tighter to reduce the amount that is put into circulation, with same being true of the interest rates. “GAO's federal simulations show that absent policy changes, the federal government faces a rapid and unsustainable growth in debt. Simulations of the state and local government sector show that not only the federal government faces fiscal challenges that will have a profound effect on government over the coming decades. A growing imbalance between revenue and spending is driven on the spending side by rising health care costs and the aging population, which in turn will lead to a rapid increase in spending on retirement and health programs.

The Best and Worst of Spending
In light of these challenges, GAO works to provide Congress and the public with updated analysis on the fiscal outlook for the federal government and for the state and local government sector and with answers to key questions about federal debt”(GAO,2012)
In conclusion, I would hope that I have shown my basic analysis of what are the most important aspects of the economy and the government deficit. It is as I said earlier there are many different opinions on how to handle the deficit and what should happen in the future. Handling the entire deficit without cutting many well deserved programs seems to be an impossible task no matter whose opinion it is.

References:
Buchanan, (2009), Everyone Seems to Agree That Budget Deficits are Harmful. Can They All Be Wrong? Retrieved from: http://writ.news.findlaw.com/buchanan/20090716.html
Case K., Fair R., & Oster S. (2009). Principles of Macroeconomics, 9th Edition. Pearson Prentice Hall. Upper Saddle River, New Jersey.
Summary of GAO's Performance and Accountability Report Fiscal Year 2011(author unknown) 2010, retrieved from: http://www.gao.gov/special.pubs/longterm/
Tutur2U (2012), (author unknown) Fiscal Policy. Retrieved From: http://tutor2u.net/economics/revision-notes/a2-macro-fiscal-policy.html