deficit

US Unemployment & Interest Rates

Today, the Canadian Finance Minister Jim Flaherty tabled a budget with plenty of emphasis on reducing the deficit, much like what’s going on in the US. This, despite the fact that the interest rates are telling a story where financial markets are not that concerned about the deficit. This pattern is evident in both Canada and the US. Interest rates are showing there’s no crowding out—government spending taking up capital and resources that businesses can use. The reality of the situation is uncertainty and a dearth of good prospects is causing the business community to sit on huge stocks of capital.

Nevertheless, for various political reasons the deficit is touted as a menace that must be dealt with, not just in North America, but globally. The media is contributing to the Jedi mind trickery, dubbed the “Beltway Deficit Feedback Loop”. The WaPo blog by Greg Sargent states::

“The relentless bipartisan focus on the deficit convinces voters to be worried about it, which in turn leads lawmakers to spend still more time talking about it and less time talking about the economy,”

while linking to a National Journal study examining the gap between mentions of “unemployment” versus “deficit”::

“the broadening gap demonstrates just how effective conservatives have been at changing the narrative of economic policy from one dominated by talk of fiscal stimulus to one now in lockstep with notions of fiscal austerity.”

In Canada, the opposition parties aren’t on the same page with the Finance Minister and the Conservative Party, but don’t have the votes to stop the budget. While ink is being spilled about how fast the deficit will be reduced in Canada and whether of not the Conservative projections are wide of the mark and overly rosy, the elephant in the living room is the lingering high unemployment rate::

2008-2011 Canada unemployment rate

The problem with the deficit discourse is it fails to address the issue of unemployment and real economic problems, with the only way the issue goes away is if the economy grows. In fact, I feel being a deficit hawk in this economic climate is playing with political dynamite. The economic indicators do not support deficit reduction, given that the business community is loathe to expand. So, if the deficit hawks are wrong and unemployment and economic stagnation persists, they are opening themselves up to criticism. I think the hope is that a business cycle upswing will render the deficit issue moot, so the perception is that it’s “riskless” to jump on the deficit reduction bandwagon.

In the US, both Democrats and Republicans are viewing the deficit as the evil menace that must be thwarted at all costs with ample help of the media. While a Republican presidential candidate would differentiate themselves by embracing a populist and expansionary economic approach, it would be political suicide. Any politician advocating increases in government spending would face an uphill battle and be forced to educate the public on matters many don’t have the time and the patience for.

The jury is still out on how the New Democrats and Liberals play the deficit card in Canada in the future, but it may be an easy one to play if unemployment remains relatively high, businesses remain tentative, and the economy continues to stagnate.

First off, I think there’s little that can be done about the forthcoming yearly deficits and total debt of the US federal government. Reigning in spending at this point will just make a bad situation worse. Nevertheless, what are the implications of the deficit. People have views about it, as Pew Research shows. It is currently #7, in terms of people’s top priorities and for the past two years, both Republicans and Democrats see it as a priority, being within a percentage point of each other. Over the years, the concern has gone up and down::

What I’m not sure is whether or not people get the implications of a huge debt. I remember in macroeconomics being taught about “crowding out”, where government spending and resultant borrowing “crowds out” entities seeking capital in lending markets and drives up interest rates.  Now, the Wall Street Journal is singing cassandra’s tune, warning that foreign creditors holding US Treasury securities is a threat to the nation’s national security and Leon Panetta, CIA Director, agrees::


I don’t see this happening. Why? I think we’re in for the dollar depreciating, as I see policies on the horizon that will lead to inflation, higher interest rates, and a devalued dollar, as does Jim Jubak at MSN. Holding the dollar won’t have the appeal it once had, given that it’s likely to devalue, and the Chinese are already curbing their appetite for US debt. In any case, this level of debt isn’t a “game over” situation and the US won’t go bankrupt, no matter which “expert” says it on CNN.

Currently, inflation is practically non-existant, as is nominal GDP {i.e., national income} growth, and interest rates are rock bottom.  The inflation and interest rates give the economy some degrees of freedom. A more troubling issue is GDP growth, which might be hindered by structural problems in the economy. We may not “grow” out of this, where economic growth increases incomes and tax revenues. Unemployment is the highest it’s been since 1983 and will be a political hot button issue in 2010.

As for deficit spending and the increasing debt, total public debt as a percentage of GDP {a debt to income ratio} is high, approaching the levels it was in the late 1940s. While the numbers are mind-boggling, the debt isn’t unprecedented.

Data sources:: CPI/inflation data from BLS, nominal federal funds rate from Federal Reserve, Unemployment data from BLS, public debt from Treasury Direct, & nominal GDP from BEA. Note:: the thickness of each band at a given year represents the rate for the given variable. Kenneth M. Kambara

I’m not staying up at night worrying about the deficit, although there will be several policy implications::

  1. The true danger of the deficit spending is if there isn’t a multiplier effect, i.e., the impact of a dollar spent is some multiple of that dollar. I’m afraid that spending may not be directed towards projects/endeavours that get the most “bang” for their buck.
  2. Too much emphasis on the deficit may hamper spending that achieves multiplier effects.
  3. Read my lips, expect higher taxes in the long haul.
  4. There will political pressure to reduce unemployment and {in my opinion} spending should focus on this, in ways that achieve a multiplier effect, e.g., jobs that also increase innovativeness and/or productivity or improve infrastructure.
  5. Expect programme cuts and pressures towards privatization.
  6. Expect reductions in military spending.

Ideally, deficit spending is an “investment” in the country when there aren’t tax revenues to cover it, as in a recession. The real question shouldn’t be how much is being spent, but how and where it’s being spent.

Twitterversion:: Are you concerned about the US deficit? Blog post focusing on the real implications of running up the bills. @Prof_K

Song:: Hem-“When I Was Drinking”

“Living it up when the rent was due
With nothing and no one to live up to”