Brad DeLong, a Berkeley economist, thinks that different rules about government spending and deficits apply during a Depression. When the economy is doing fine, he estimates, $1 of government spending yields 40 cents in extra production and related jobs. But in a Depression, the $1 yields $1.50, more than three times what it would under good conditions. With the federal budget deficit at a record $1.4 trillion, DeLong's argument would suggest that Dick Cheney was partially right when he said, "Ronald Reagan proved that deficits don't matter."
Before getting into the details of why DeLong thinks the multiplier effect on government spending is so much higher during a Depression, it's worth discussing whether we're in one. That's because so many economists -- including Ben Bernanke -- seem to suggest that we're not even in a recession anymore -- and we're going to start enjoying economic growth in the next few months. If so, DeLong's argument that we need more government spending would seem hollow.
But, as I've posted, with 15.1 million unemployed and 70 percent of GDP growth coming from consumer spending, I'm sympathetic to DeLong's argument that the U.S. is actually still in a Depression -- particularly when you consider that the National Bureau of Economic Reseach (NBER), to which he belongs -- dated the beginning of the current recession to December 2007 -- the month that job growth went negative. So why does DeLong think that deficits are good in a Depression?
At the core of his argument is the idea that government spending during a Depression keeps people on the payroll who would otherwise be collecting unemployment and not paying taxes. So if you spend $100 billion more government money, you get $150 billion in increased production and incomes in the year the money is spent and $800 million a year more in future years.
Spending in a Depression has other benefits:
- It generates tax revenue. For example, he estimates that $150 billion of added production leads to $60 billion of additional tax revenue, limiting the debt increase to $40 billion.
- Interest rates remain low and provide government with cheap capital. Federal borrowing at 2 percent per year for the next 30 years means that amortizing the $40 billion of additional government debt leads to only $800 million a year in additional interest payments and taxes.
- Low rates mean less government borrowing to compete with private investment. According to DeLong, the absence of interest rate increases means no crowding out of private investment. Thus, future private-sector incomes are not affected.
DeLong argues that the federal government should spend $100 billion a month until the economy starts to create enough new jobs to put those 15 million unemployed back to work and inflation starts to kick in.
I just hope that China will have enough appetite for the additional debt required to finance the deficits that this plan will create. Otherwise, federal interest expense could seriously crowd out private investment as the Fed increases interest rates high enough to sell the needed debt.