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The Calculus of Deficit Spending

A Chart For The Super-Committee's Immediate Attention

By: Repair_Man_Jack (Diary)  |  November 14th, 2011 at 01:12 PM  | 

RESIZE: AAA

The Trend Is Not Our Friend

Mathematicians often rely on the old saw that a picture is worth a thousand words. The picture displayed above is Coyote Morning Ugly. Christopher Rupe and Nathan Martin of EconomicEdge.Com have examined the marginal utility of America’s continued deficit spending over time. Quite simply put, each year’s deficit spending produces less present value per dollar spent.

In 1966, we got about $0.75 per dollar of debt in present benefits. By 2010, the average trend was down to about $0.10. We lose $0.014 per year in present value from deficit spending. Even pulling the “inverted hockey-stick” year of 2010 out of the data would do little to improve that present trend.

Extrapolating this out seven more years gives us a zero marginal productivity for deficit spending. That would be the point at which every dollar of deficit spending no longer had a positive impact on GDP. Is that what literally has to happen before people realize that our current levels of national government spending will lead us to national suicide?

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  • http://www.twitter.com/AWG9_yoyo yoyo

    …is what is causing the decline.

    Is it the debt? Is it what it is spent on? A combination of the two? Or is it that America is producing less, period, and as such the ratio would downward trend regardless?

    It is a bit vague — along with “marginal return of America’s deficit spending over time.”

    This seems to be data supported by a conclusion instead of a conclusion support by the data. And maybe I am wrong – and that would serve to explain why I am neither a mathematician or a statustician.

    Thanks for the info and food for thought.

    • Repair_Man_Jack

      What causes the marginal productivity to decline could be well worth another diary. I’ve limited myself to two RS diaries a day, but I’ll philosophize for a bit.

      1) Corruption. I hit that today. But things like the Penn State Affair, the Congressional insider trading and the rest eventually do cost real money. (e.g. Birmingham, Al’s bankruptcy was the result of dishonest, corrupt government.)

      2) Debt Service. This becomes a little like the old Fibonnacci Sequence recurrance relationship. The more you borrowed yesterday, the more dead weight spending you do today to cover it up. It’s like viscous drag in a Navier Stokes Equation problem. You don’t notice that crap until you notice it. By then, your answer is wrong and it’s too late. You really see a latent form of the GDP drag from prior year’s debt on that chart I put up.

      • Death_of_the_Donkey

        the first aircraft carrier we build has a huge marginal effect, the 1000th, almost none. This is essentially also why the application of Keynes today is so off, as the marginal utility of each deficit dollar is so much less than what it was when deficits were small/non-existent (as Keynes assumed when he wrote his theory).

      • tankertodd

        The GDP equation counts investment, consumption and government spending. If we borrow a dollar today that’s a dollar in the future that won’t be spent/invested/spent, so that takes from future GDP. If the calculation considers present value, I assume the calculation includes the future drag on GDP.

        So just as interest compounds positively, is the opposite effect applying here? A dollar borrowed today impacts even more on GDP given the longer time to repay?

    • renl57

      Notice that this chart begins in 1966, just one year after Medicare was enacted.

      In the old days, Government spending (which increased debt) went to productive things like highways, the air traffic control system, etc.

      But the U.S. population has been steadily aging, and so Social Security and Medicare are consuming an ever larger share of the Federal budget. 43% of the Federal budget now goes to SS, Medicare and Medicaid.

      So we’re now spending $1.5 trillion every year to pay retirees who by definition are no longer producing anything that adds to GDP. You could double that to $3 trillion and the retirees still won’t be producing anything.

      Every country on earth, such as Japan, that is experiencing an increasingly aging population is watching its economy slow down despite increasingly desperate attempts by the government to stimulate it.

      You can’t stimulate an old-age home into producing goods and services.

      If I’m right, then there are only 2 solutions to this (not mutually exclusive):

      1. Raise the SS and Medicare retirement age, and force healthy older people to keep working at productive pursuits.

      2. Lower the median age of the population by having more children. Throw away your contraceptive Pills, your condoms, your rhythm method calendars. Grab your honey and make more babies!

  • bonnman

    for clarification. Thanks.

    • Repair_Man_Jack

      http://www.oftwominds.com/blognov11/drowning-in-debt11-11.html

      • toothpick

        I checked the link. Interesting points but the link definitely doesn’t share how the graph was generated. How did they decide that in the 60s, incremental debt of $100 would lead to $70 GDP growth? Why should I believe that borrowing from the current generation and leaving the debt to the next automatically increases economic activity? Doesn’t it matter a great deal what the money is spent on? For example, if we spend it building an Interstate Highway System, that would surely have a different impact on the economy than if we spend it on blowing up dams or conducting multi-year studies of the potential impact of a gas pipeline on flightless waterfowl in Nebraska.

        While the chart is satisfying in that it reinforces my own pre-conceived biases about deficit spending, I don’t think this article proves the point. Sorry, this one misses the mark for me.

        • Repair_Man_Jack

          You get down to the “multi-year studies of the potential impact of a gas pipeline on flightless waterfowl in Nebraska.” once you’ve run out of Interstate Highways that would actually carry people and materials to somewhere useful. That’s part of what marginal utility represents.

          Also, I think your seeing a second-order effect of what previous people spent in deficit in prior years. The interest spending is non-productive and siphons off available minies. Divide total Delta GDP by Delta Debt and you’ll see the impact of the interest payments on the prior debt buying you nothing.

          • johnt

            to the rent seekers, productivity lies stagnant or declines. Our current deficits are funded by Fed action & as The O will tell you we have to repair things, many things, endlessly, the very ones whose maintenance we pay and have been paying for, as well as the “underpaid” school teachers, and a massive group of preferred beggars throughout.
            The last thing the billions are or would be spent on are productive pursuits. You don’t steal a nation blind that way.

          • toothpick

            …and the points you are making. I just don’t think the article you sourced makes an adequate case for it. Nor do I trust the graph you used in this posting, without understanding the source of the data.

  • joecollins

    We could reduce our federal deficit if we cut out the federal crony crap such as Solyndra, Lighthouse Squared, Not Needed Small Pox Vacinations . . . .

    A half billion here, a half billion there, pretty soon we are talking real money.

  • aesthete

    I share concerns about whether this is *correlation* or *causation*, though: certainly, having it be a causation would confirm my small-government biases, but I would like to see an explanation of this data that is more comprehensive than the one provided at the link. A general explanation which may be consistent with the data would be that spending on the elderly (pensions and healthcare) yields low marginal returns, and that our increased spending in those areas are drowning out the “good” government spending (infrastructure or whathaveyou).

    It’s still interesting data, though, and at least disproves the notion that higher government spending is always and everywhere a panacea.

  • http://impudent.edublogs.org/ kyle8

    the single stupidest idea to ever be foisted upon otherwise intelligent and educated people since Marxism.

    It cannot possibly work because of the crowding out effect and because of expectations of higher taxes and inflation to come.

    No amount of fancy economic theories nor government programs can change the basic fact which everyone should have learned in grade school: Debt is BAD!

    Debt is at the root of all recessions and all bubbles, it is at the root of all bad money policies and at the root of all financial meltdowns.

    Too much debt is the ruin of nations.

    • buddyp

      You write:
      It cannot possibly work because of the crowding out effect and because of expectations of higher taxes and inflation to come.

      Economists of all stripes would generally disagree with your absolutism and your reasoning behind it.

      The negative effects you mention do not necessarily fully offset the positive (short-term) effect of Keynesian stimulus.

      Crowding out effect, for example, isn’t much of a factor when interest rates are extremely low and unlikely to go higher (or significantly higher) as a result of incremental federal borrowing for stimulus.

      Re: “the expectation of higher taxes” — i.e., Ricardian equivalence — I think few economists believe in full Ricardian equivalence.

      I realize the factors you mention can compound one another, but still, you overstate the case. The net effect depends on various economic conditions in which the Keynesian stimulus occurs. It’s certainly possible for it to generate incremental GDP and employment in the short term, and my sense is that economists consider that more likely than not in most circumstances.

      What concerns me is the longer-term adverse effects of greater debt, due to eventually higher interest rates and eventually the need to repay the debt, particularly with much of it going to foreign bondholders, plus the possibility of monetization that would spur harmful inflation.

      For this reason I cringe when I see some (generally on the left) saying that now is a great time for government to borrow because interest rates are so low. It’s lilke someone who already has too much debt and who already seems stuck in a pattern spending more than he makes, saying he should borrow the maximum on some credit card with a low intro offer interest rate. Still has to be paid back someday, so unless it’s invested in some way such that it generates funds to pay it back (unlikely for government, which will spend much of it on current consumption, not investment, let alone positive NPV investments), the extra debt is plenty expensive even at a low interest rate. In other words, even in that case, I say to those on the left making that “cheap money” argument: “It’s the principal, stupid.”

      I’m not against Keynesian stimulus in all situations. I think sometimes it’s worth the extra debt to cushion bad times and possibly to halt and perhaps reverse a downward spiral of economic psychology and behavior (the “paradox of thrift”, etc.). But I’m certainly not an enthusiastic or reckless fan of it either. It generally comes with a price in the long term, and given that we are already in bad shape for the long-term, we shouldn’t be quick to add to the eventual cost.

      • http://impudent.edublogs.org/ kyle8

        In the first place most economists are now quite skeptical of Keynesian.

        In the second place your casual dismissal of the crowding effect goes in the face of evidence which we have seen recently. The interest rates do not enter into it. High or low interest rates, the money for the stimulus must come from somewhere, It comes from the pool of capital otherwise available for actual investments.

        The expectations are not RIcardian. so you are wrong there too.
        It is not whether the public cares how the government is financed, it is the AMOUNT of government that matters.

        If businessmen see record high deficits then they know that record high taxes or inflation are just around the corner and so they make plans accordingly.

        If you still believe in Keynesianism at all then you are foolish.

        It didn’t work in the 1930′s, it didn’t work here or in Europe in the 1970′s, it didn’t work in Japan in the 1990′s, and it hasn’t worked recently.

        If you make an hard to believe assumption then it requires extraordinary evidence before it should be acted upon.

        Well, not only is there no extraordinary evidence, but all the evidence is negative.

        So why, logically would one wish to take on crippling debt with so little evidence of a positive effect?

        Only a fool would do so.

        • buddyp

          I don’t wish to offend, but I must say that you simply have no understanding of this stuff, despite your seemingly confident, bold assertions (or perhaps the boldness and demonstrative confidence are meant to substitute for a true sense of understanding, as a sort of bluff).

          You write, with my emphasis added if my bolding html works:
          your casual dismissal of the crowding effect goes in the face of evidence which we have seen recently. The interest rates do not enter into it. High or low interest rates, the money for the stimulus must come from somewhere, It comes from the pool of capital otherwise available for actual investments.

          You obviously do not understand the crowding out effect at all if you think interest rates are irrelevant. I suggest you read some summary explanation of “crowding out effect” before you claim to understand it (let alone claim superior understanding of it over someone else). I’ll make it easy for you if you’ll only give it one minute.
          Just read this quick explanation.

          You write:
          In the first place most economists are now quite skeptical of Keynesian.
          and
          If you still believe in Keynesianism at all then you are foolish.

          You seem to think one’s view of Keyensian effects is all-or-none (whatever “all” would be), rather than the matter of degree that it is, and also affected by the state of the economy (e.g., level of unemployment; GDP growth or recession, etc.). If you mean to assert something more sensible, you should say what you mean. I rather doubt most economists think there is nothing to Keynesianism in terms of short-term stimulative effects. In fact, I’ll bet few if any respected economists have that view. Even the person who is probably the most prominent and aggressive critic of Keynesianism, Robert Barro, apparently does not argue that the multiplier from deficit-financed stimulus is zero. Rather his argument is that those who contend that it is greater than 1.0 are unjustifiably optimistic, and that it is difficult to sort out the data clearly, but that his own research shows multipliers generally greater than zero and below 1.0 at least in the short term, meaning that the amount that the incremental government spending adds to GDP is partly offset by a loss in the private sector’s contribution to GDP, but that the two net out to an increase in GDP in the short term. See
          The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP, but will do so by less than the increase in government spending. See his discussion of multiplier levels here. And note that he concludes, with emphasis mine:
          The bottom line is this: The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending.

          You write:
          The expectations are not RIcardian. so you are wrong there too.
          It is not whether the public cares how the government is financed, it is the AMOUNT of government that matters.

          Yet again, you simply have no idea what you’re talking about. I really suggest you take at least a couple of minutes to find out what terms and concepts are before thinking you have some understanding, much less saying someone else is wrong. In your initial comment to which I responded, you noted the expectation of higher taxes as one of the reasons stimulus spending supposedly “can’t work”. Presumably your point is that taxpayers will consider that more government spending will, sooner or later, require more taxation, and they will therefore save that much more, offsetting the intended stimulative effect of the spending (i.e., that the amount the government adds to aggregate demand is withdrawn from aggregate demand by taxpayers). That is Ricardian Equivalence. Look it up.

          • http://impudent.edublogs.org/ kyle8

            You are correct that is the definition of the Ricardian equivalence, and perhaps I did not state myself correctly. Originally the point was that if a nation funded a war, for instance, it did not matter to the public whether it was funded with taxes or deficits.

            In this case, what I am trying to say is that the Ricardian equivalence is a very real phenomenon when the amounts become scary and unsustainable. The more modern term for this is regime uncertainty.

            IF we were talking about a small amount of deficit spending then perhaps the effects on the actions of individuals and business would be small or undetectable, but when the amount is huge, and when we have the example of other nations not being able to meet their obligations, then the effect is real and profound.

            I am sorry if you think my pronouncements are a bit too assertive, but you did not answer my challenge. I am assertive because, quite frankly, the use of government stimulus has never been shown to get a nation out of a recession.

            And since the effects of high amounts of debt are very real, and very negative, then there ought to be a corresponding proven benefit. But no such obvious benefit occurs. So if we are still arguing about the size of the multiplier, then I pronounce it snake oil.

            And yes, I really do know what I am talking about, at least I have a good working knowledge of basic economics. One day, not too far in the future I predict that the very idea of Keynesian stimulus will be looked upon with disdain by everyone.

            It has caused a world of harm to the economies of several nations.

            Now your first point is wrong. Interest rates do not really matter. What matters is that there is a pool of capital. Capital comes from savings or the sell of assets. Capital cannot be created by government fiat.

            If capital markets are investing in government bonds then the supply of capital for real investments is limited. I say that interest rates do not matter because it is a given that the government debt will be priced at a rate that lures some investors. Currently a lot of our debt is being supplied by Chinese and other nations using dollars they earned through trade with us.

            IF this money were not used in this way then it is reasonable to believe that some of it would be used to purchase assets in the USA. This would increase the level of capital available.

            So, now tell me, where exactly has a Keynesian stimulus ever been used to jump start a nation out of a recession? Is there even any evidence that recessions which had a large amount of government stimulus recovered more quickly than the average?

            The entire idea is garbage. But it would be so nice if it were true wouldn’t it? we would never have to have an economic downturn, we could all spend like drunken sailors and we would all be rich!

          • aesthete

            is that Keynesian policy prescriptions are rarely enacted in good faith. To explain why that is takes a whole ‘nother branch of economics — public choice theory, to be precise. Given the constraints that we have on acquiring good faith Keynesian policy-makers, debating Keynesian economics in the real world seems to me to be the equivalent of debating the feasibility of a new form of brain surgery when the doctor in question is a rhesus monkey: regardless of whether said brain surgery works in some counterfactual where a professional is administering it, we are asking whether the monkey should do it in the next five minutes. The answer to that question should be no, and the same reasons generally apply to why we shouldn’t place power over the economy in the hands of the US Congress or the President.

          • http://impudent.edublogs.org/ kyle8

            The best any Keynesian can come up with is “Well it has some positive effect in the short term” That is simply not good enough to saddle a nation with a lot of debt.

            We know what it takes to grow an economy, it is no mystery. Sound money, sound lending practices, predictability, low marginal tax rates, and a favorable business & regulatory climate.

            That is what it takes, and those are the only things proven to work. They may not be sexy, but they work.

          • aesthete

            but more because I’m morally opposed to debt and theft than because I have a strong belief that Keynesianism has been theoretically disproven, as Marxism has. (Though the New Classicals have done some interesting work when it comes to “refudiating” some of the Keynesians’ most cherished beliefs.)

            At any rate, I don’t think you can go wrong with what you suggest. Add free trade and somewhat free labor markets, and I think you’ve got a winner.

          • http://impudent.edublogs.org/ kyle8

            the more I learn the more I really think the whole aggregate demand stimulus thing is a sick joke on a colossal scale. It really just boils down to little more than “lets tax, spend, and borrow our way to prosperity.”

          • buddyp

            Kyle,

            Re: Is there even any evidence that recessions which had a large amount of government stimulus recovered more quickly than the average?

            I don’t have a direct answer to your question, and I’d say that it’s not the only question, although it’s one important one. I would say again, though, that it seems there is general agreement among economists of all stripes that the immediate multiplier of deficit-financed stimulus spending (and of deficit-financed stimulus tax cuts) is greater than zero, meaning that short-term GDP is greater as a result. But I don’t know either (1) whether or not that tends to be large enough to erase all negative GDP growth (degree of recession), or (2) if the answer to #1 is “no”, whether or not the effect nevertheless shortens the recession in conjunction with other elements of recovery. But again, that’s a matter of degree.

            Directionally though, deficit-financed keynesian stimulus spending or tax cuts generally cause greater GDP than we’d have otherwise. I suppose exceptional cases could occur if the reaction of the bond market were so severe that interest rates jumped so high that this negative effect was greater than the positive immediate effect of the intended stimulus.

            Re: crowding out, I think you’re still not getting it, despite what I think is a clear definition and explanation at the link I provided. I’ll try my own words: The problem with crowding out is one of supply and demand for capital. If government is demanding more, and if that increased demand substantially drives up interest rates generally, borrowing for purchases and investments by businesses and individuals in the private sector becomes more expensive, which reduces this economic activity, lowering GDP.

  • ja_ak

    The chart could be boiled down a bit. If I hold spending constant (for simplicity) and in year 1 I have to borrow $100 at 5%, I can apply all of that $100 to good works…arguably. However, in year 2, I now have to borrow $105 to get teh same $100 benefit (simple interest)…in year 3, $110, in year 4, $115…if I don’t borrow the extra amount, then my impact of the borrowed amount goes down. The borrowed $100 in year 2 only buys $95 of benefit. In year 3, it only buys $90. Etc.,etc. – eventually I’m borrowing only to pay interest, at which point my marginal utility is zero, and about to go negative – I’m going to be borrowing just to pay my interest, which continues to increase the interest I owe, so I borrow more…That would be a death spiral.

    • http://impudent.edublogs.org/ kyle8

      And they are dragging down the rest of Europe, not that the others don’t also have a problem with deficits.

      We are not immune and if we don’t derail this train soon we are headed strait to fiscal hell.

  • gogo

    “That would be the point at which every dollar of deficit spending no longer had a positive impact on GDP. Is that what literally has to happen before people realize that our current levels of national government spending will lead us to national suicide?”

    The people realize it and want all the spending stopped. It is Congress that does not get it. The Obama admin gets it but they are determined to financially destroy the US in 4 years and that is on schedule to happen.

    Jellyfish Boehner thinks the debt and spending is no big deal. To him, it is just business as usual. Ever since he has been in office, 20 years, Americans have complained about the spending and debt and yet the US govt just keeps plowing forward. Jellyfish cannot see what it right in front of his face and he is leading the House GOP over a cliff.