A balanced budget isn't always good fiscal sense

[Darth Wong]

Any economists in the house who'd like to critique this? It makes sense to me, but I'm not an economist.

A balanced budget isn't always good fiscal sense

While Washington's budgetary insanity makes Ottawa's fiscal probity all the more appealing, balanced budgets are a cross that Canadian finance ministers should not always have to bear.

Of course stateside anything remotely close to a balanced budget won't be seen until at least 2010. Wrestling down Washington's $500-billion-plus (U.S.) deficit will require painful multiyear exercises in fiscal restraint.

And it isn't just tax cuts for the rich that will have to be unwound. President George W. Bush may talk the talk with the best of the fiscal evangelists in the Republican Party, but discretionary spending is on fire during his watch. It rose at double-digit rates for the past two years. Compare that with the actual spending cuts under some of the Clinton budgets and you'd think the latter was succeeded by Franklin Delano Roosevelt.

That's of course going to change in a hurry after the elections. It will take restraint measures just to prevent Washington's deficit from growing. After artificially boosting the economy, budgets will be artificially restraining U.S. growth, not only in 2005, but also for the rest of the decade.

That pending shift is not without consequences north of the border, where balanced budget have become enshrined as fiscal orthodoxy. But Ottawa's fiscal righteousness has been at least partly aided by the trickle-down stimulus the Canadian economy has received from both of Mr. Bush's massive tax cut packages.

Mr. Bush's boost to exports has more than offset the economic drag from Ottawa's own budget surpluses. Never, in fact, during the past 30 years have the two federal governments been more fiscally out of sync. Having U.S. taxpayers deficit-finance demand for Canadian exports is a good gig if you can get it. But the only thing that will be trickling down to the Canadian economy from future Washington budgets will be the impact of big spending cuts and big tax increases.

Yet, the overriding imperative for the coming Canadian federal budget will be to balance the budget at all costs. Any deficit, no matter how slight, will be seen as a policy failure. While many Canadians may want to continue to live in this state of fiscal grace, few recognize what it implies.

Without the slightest public or parliamentary debate, the federal government has effectively adopted the "balanced budget resolution" that even a surplus-presiding Clinton administration wisely rejected. Bill Clinton opposed Congress's call for a constitutional amendment outlawing federal deficits because it would have turned the clock back on 70 years of economic theory and practice.

There are many thing we do not know in economics. But one thing that we do know is that government revenues decline during economic downturns, leaving in their wake budgetary deficits. Deficits occur even under a neutral fiscal stand, because declining government revenue is not driven by policy measures such as tax cuts, but from a faltering tax base.

If government responds by raising taxes or cutting spending to protect its budget balance, policy will have swung to a contractionary stand. And it will do so precisely when the economy is already contracting. No Group of Seven country would choose to do that. Only the International Monetary Fund prescribes that kind of medicine, and with predictably lethal results for the countries that are forced to swallow it.

The Canadian economy may not yet be in a recession, but only a fool would think one will never come around. Yet, if every federal budget must be balanced, if not by constitutional amendment then by scripture, then Ottawa is setting itself up to make some huge fiscal policy errors when the economy turns south. It would be as if Ottawa voluntarily imposed IMF sanctions upon itself.

Drawing a line in the sand on a balanced budget may still be good politics, particularly in a budget that will serve as an election platform. But whether Ottawa posts a $5-billion (Canadian) surplus or a $5-billion deficit is of trivial importance to either our economic performance or to our creditworthiness. That's not old-fashioned Keynesian economics talking; it's simple arithmetic in a more-than-trillion dollar economy.

What's important is not how many consecutive balanced budgets the government can deliver, but that fiscal policy is flexible and can respond to rapid, and often unanticipated, changes in economic conditions. Not all budget surpluses are unambiguously good and not all budget deficits are unambiguously bad. The same policies that rescued the country from its fiscal morass in the 1990s may in fact be an unnecessary and undesirable burden today.

Huge policy-mandated deficits have bound U.S. policy in a straitjacket for years to come. Let's hope Ottawa's own "balanced budget amendment" doesn't strap Canadian policy in a similar suit.

[Arthur_Tuxedo]

Didn't see anything that an Intro Micro or Macro textbook would disagree with.

[Master of Ossus]

Didn't see anything that an Intro Micro or Macro textbook would disagree with.

You won't. The guy's reasoning is backed up by decades of economic data, and it is sound. A balanced budget is only supported within economic circles by the fringe group termed "monetarists," who among other strange beliefs feel that the government is entirely responsible for the real business cycle (!). The truth of the matter is that the government SHOULD run a deficit by spending money during an economic downturn. They can then cut discretionary spending during the resulting upswing, once the recession is over, and ideally the deficit won't grow substantially once everything is said and done. In practice, of course, things don't work this way because the government has a LOT of difficulty cutting programs that they installed during a recession in an effort to battle the recession through increased spending, but a balanced budget can severely hamper the ability of the government to control the economy by removing a potentially powerful and important tool from their arsenal.

[Alex Moon]

The guy seems to be repeating what the vast majority of economists will tell you. The government's ability to deficit spend isn't always a bad thing, especially, as the author points out, during recessions or emergencies when it may be necessary to spend a large amount of money quickly. If you were forced to raise taxes in order to pay for every spending increase right away, then you'd kill the economy overnight on even the necessary spending. The biggest problem is when deficits become written into law in such a way that they are guarenteed (example: social security) to be there for years into the future. Even the deficits projected from Bush's spending will only come out to about 4-5% of the GDP, which is not a serious problem. It would be equivalent to running up a credit card bill of 4-5% of you income in a year.

Bill Hobbs has a good article on this

Consider this: If you made $24,000 this year, and spent $34,000 by putting $10,000 on your Visa, your "deficit" would be $10,000 - and would be a rather large problem. But if, say, 10 years later, your income had risen to $100,000 a year, and you spent $120,000, your deficit would be larger in real dollars but smaller as compared to your ability to finance it.

The 1992 deficit equaled 4.7 percent of the nation's gross domestic product, according to historical tables in the White House's official 2004 budget document (see page 25 of this PDF file). That was not a record. During the Reagan era, the largest deficit as a percentage was 6 percent in 6 percent in 1983. That was not a record. In 2002, the deficit was a mere 1.5 percent of GDP.

http://billhobbs.com/hobbsonline/003166.html

[Darth Wong]

Hobbs' example assumes that the economy grows faster than the debt.

[Alex Moon]

Hobbs' example assumes that the economy grows faster than the debt.

Which is what we've seen historically. The average percent growth per year of the US GDP from 1930-2003 was 3.55%. The average percent growth for the Debt: .91% The Debt-GDP ratio for the US since the Revolutionary War has only broken 1 once, and that was during WWII. The next highest it's been is approx .6, and that was During the Reagan years.

[Darth Wong]

Hobbs' example assumes that the economy grows faster than the debt.

Which is what we've seen historically. The average percent growth per year of the US GDP from 1930-2003 was 3.55%. The average percent growth for the Debt: .91% The Debt-GDP ratio for the US since the Revolutionary War has only broken 1 once, and that was during WWII. The next highest it's been is approx .6, and that was During the Reagan years.

You're speaking specifically of the US. I was speaking in more general terms. And I was intrigued by the notion that my own country's economy is currently being floated by Bush's deficit spending, and that the inevitable belt-tightening which follows the election (assuming Bush is not completely insane) will drag us down with it.

[tharkûn]

It is a pretty valid idea that in some times deficit spending is unavoidable, and a balanced budget would make things worse. The problem comes in that politicians don't realise you need to have a balanced budget on average.

Bush's fiscal policy is not entirely insane. The basic idea is that taxation acts as a damper on economic activity. If you provide a service for 20 bucks (but cannot cut your prices) and I am willing to pay 25 bucks for that service (but no less) than any tax rate over 20% implies that we won't do business. You'd have to charge more than 25 dollars or receive less than 20 back. So if the government goes to a 25% tax rate, then they lose money because we don't do business.

Economically it is called the Laffer curve. If the government has no taxes it takes in no money; if it has 100% taxation it takes in no money (because people being inherently selfish will not work for no reward). It is assumed that the relation between tax rate and government revenue is a continious function with no changes in concavity so at some point the government hits a tax rate, denoted T*, where revenue is maximized. Basically at some point there is a trade-off between a higher percentage of the economic activity going to the government and the government damping economic activity. Bush, right or wrong, subscribes to this economic theory and further beleives that US economic policy is to the right of T*. He is betting that the economy will grow sufficiently to more than make up the loss by percentage.

It might not be right, but that is his premise and I think a Nobel winning economist or two have signed off on it.

You're speaking specifically of the US. I was speaking in more general terms. And I was intrigued by the notion that my own country's economy is currently being floated by Bush's deficit spending, and that the inevitable belt-tightening which follows the election (assuming Bush is not completely insane) will drag us down with it.

Bush could keep up the present level of deficit spending for another decade without too many problems. All the investors out there assume that somebody else will buy more T-bills to pay them back; at the current abysmally low return the entire debt could roll multiple times before anyone stops worrying about default or hyperinflation ruining their investment. Crowding out and bumping up the interest rate might give some headaches, but as long as US government debt is considered the safest investment on the planet, nothing will force Bush to stop spending in the red.

In any event I thought Canada's economy was more or less tied to the American economy. Boom's have happened under tight budgets and under loose budgets. Busts have occurred with massive amounts of red ink and when the government was running heavily in the black. I don't think anything terribly out of whack will occur.

[Stuart Mackey]

Looking at this article, it seems to be an argument against legislative straightjackets. For a goivernment to arbitrairily tie itself to a balanced budget is stupid as circumstances may mean that this is the wrong choice.

My own veiw is that everything depends on your economy and how it works and how big it is in relation to others. The US can get away with deficeit spending so long as no one calls in the debts..which they wont, probably, due to the size of the US economy and the result of such an action globally.
NZ, on the other hand, has to run a balanced budget for similar reasons that Joe Bloggs has to, ecepting that our ability to gain credit is ruined, a nation seldom faces a 'repo man'.
So long as we can sustain the cost of credit a deficeit is tolerable but not ideal as interest payments is a loss. Providing the NZ economy grows and our government runs a surplus then all is good.
No government would ever rule out deficet spending..to do so is to play russian rulette with a nations standard of living/way of life.