Does the return on government spending triple in a Depression?
Filed under: Economy
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.
Peter Cohan is a management consultant, Babson professor and author of eight books including, You Can't Order Change. Follow him on Twitter.
D-Day for Harry Reid: Can he wrangle 60 votes for Senate health reform bill?
Fed stalls on Chinese bank deal, costs taxpayers $1.7 billion
Dell in a handbasket: Should founder Michael Dell resign?
Reader Comments (Page 1 of 1)
10-19-2009 @ 6:20AM
don wilson said...
respectfully your articles numbers don't add up, again respectfully are you a democrat, or a member of obama's media outlet, attempting to make us understand their view, good luck to ya. p.s. lets see if this comment is entered on site, thanks
Reply
10-19-2009 @ 6:29AM
don wilson said...
respectfully, what does your comment have to do with the article, as the guidelines of the comment area specify, whatever, please don't mail back, cause i really don't give a hoot, and i will only delete ur mail unread. good luck to ya
Reply
10-19-2009 @ 6:32AM
don wilson said...
comment #3 was only meant as a reply to comment #1, and not to be on the comment section, but whatever, good luck to y'all
Reply
10-19-2009 @ 9:16AM
jd said...
respectfully, since our economy has only been in financial collapse of this magnitutde twice in 100 years, each time after republican leadership drove our financial system off of a cliff, respectfully, it took massive federal investment to breath life back into the mess left behind. respectfully, you have no clue what you are talking about or how to fix what you broke, AGAIN! respectfully, party politics is a part of the problem not, in any way, a part of the solution. respectfully, you offered no solutions, just complaints. respectufully, thanks for nothing!
Reply
10-19-2009 @ 10:56AM
richard said...
People on the right nowadays are ridiculous. If it's news they don't want to hear it's biased. Go to Glenn Beck for real news-sure! An academic offers his belief as in this article and you foolishly dismiss it. Yes, it's quite possible he has a left wing bias but we should not dismiss ideas out of hand as the right seems to do nowadays. The right has good ideas and we need to listen to opposing opinions for the good of our nation. Just choose who you listen to. I'd be much more inclined to listen to George Will or Newt Gingrich than Glenn Beck.
But this is the right now-birthers, conspiracies, Obama is Hitler, the deficit that Bush created now, all of a sudden, matters!
Reply
10-19-2009 @ 12:11PM
Tech said...
OK, yes they could print as much as they wanted as long as we controlled the middle east with our military and oil which backs the dollar. However this is now affecting the dollar's value as the military spending is tax money and selling trillions in bonds to China and Japan is no longer an option. So what we see is moneytizing the debts, printing up paper and "buying our own bonds". Unless the USA actually makes money buy making tradable goods, food or selling resources the dollar will sink. We now longer export oil or gas but import over 65%. Manufacturing has been outsourced to Chindia, Mexico etc. for lower labor costs, and flushing trillions into government spending and the military is just draining money from positive investments and also horrifying the world. We do have some agriculture(heavily subsidized), land, some natural gas, water, and some minerals but not enough to pay off the over 100 trillion in debts and unfunded liablities racked up by the banksters selling us out into their New World Order. They will step in after the collapse and "save us" buying up everything for pennies on the dollar and having us adopt somenew global currency scheme they have tight control over.
Reply