So, I’ve been debating an economist called Mark A. Sadowski over at Scott Sumner’s TheMoneyIllusion blog. The debate started on my blog when we were debating the effects of the QE programs on my post a few days back but it has since moved on to macro-theory and a brief discussion of how fiscal deficits work and it has finally fallen onto the topic of being something like an empirical discussion of the budget deficits in the US versus those in the Eurozone.
In one comment Sadowski wrote the following,
Raw general government deficits imply that fiscal policy in Spain Ireland and Greece was far more expansionary than in the US from 2003 to 2009 and has been substantially less contractionary in Spain and Ireland than in the US since 2009. This contradicts what you have said about their relative fiscal stance far more severely than the cyclically adjusted measures.
This is in response to a comment I made to the tune that whether the deficit spending comes from active fiscal policy or from automatic stabilisers matters little. I think I should probably clarify this: it is certainly correct that the source of the spending largely doesn’t matter, however when trying to conceptualise how large one budget deficit was relative to another it certainly does matter.
For example, Sadowski is largely correct that Spain’s absolute fiscal stance is laxer than the fiscal stance in the US but in Spain’s case it is driven purely by the automatic stabilisers. What we see in Spain is a very specific dynamic that runs something like this.
1) In 2008 the Spanish budget deficit opened up as the automatic stabilisers kicked in. It reached its height in 2009 when the deficit was around €116429m.
2) The Spanish government then undertook austerity measures to shrink the deficit.
3) These austerity measures largely failed and today we do not see much change in the euro value of Spain’s budget deficit. At the end of 2012 the deficit was still €109572m.
In the US, however, the dynamics were entirely different and this was due to the fiscal stimulus undertaken in 2009 and the relatively lax fiscal stance that was taken after this. The US dynamic runs something like this,
1) In 2008 the US budget deficit opened up as the automatic stabilisers kicked in. But shortly after this, in 2009, the Obama administration launched an $831bn stimulus program.
2) This program added to the deficit in the coming years substantially over and above the effects that the automatic stabilisers had on the economy. The CBO estimates that 90% of the impact of the program had been felt by the end of 2011.
3) If we take the US Treasury’s measures of the deficit in these years we will see roughly how much the stimulus supplemented the automatic stabilisers. The Treasury measures were as follows:
2008 – $455bn
2009 – $1,417bn
2010 – $1,294bn
2011 – $1,299bn
2012 – $1,089bn
Now, if we follow the CBO and allow that 90% of the $831bn stimulus program had been spent by the end of 2011 this means that $748bn was spent in this period. Given that this was a three year period we can average out that the stimulus added around $249bn a year to the deficit. We can express how much the stimulus increased the deficit in each year in percentage terms as follows:
2008 – 0%
2009 – 17.6%
2010 – 19.2%
2011 – 19.2%
2012 – ?%
So, what does this tell us? Let’s think of it this way. The Spanish recession caused an endogenous increase in the deficit and then began to try to cut this same deficit. They failed. The endogenous deficit that was run in Spain was keeping the economy from falling into a protracted depression but it was not sufficient to return the economy to even modest growth.
In the US the endogenous deficit that opened up was supplemented by a stimulus program that added to this deficit by about 18% a year between 2009 and 2011. Thus on top of the endogenous deficit that we would have seen anyway — and which would have merely kept the economy from falling into a depression, as it did in Spain — the US added an extra 18% which gave the economy the momentum to return to modest growth. A good deal of this, as I said to Sadowski, was due to the impact this additional demand had on investment in those years which has almost recovered in the US to pre-2008 levels — see here.
Here is a nice way to think of this: automatic stabilisers will merely stabilise your economy. They will make up for the shortfall in demand to the extent that your economy will not fall into a total depression. But they need to be supplemented with stimulus to generate a cyclical upswing as we saw in the US. This explains why the US is experiencing modest growth right now while countries like Spain are stuck in a rut.
Update: It appears that the above post was incorrect in its assertion that there was no stimulus in Spain after the 2008 crisis. In fact, there was. I am currently addressing this in the comment section (see below) and will likely have some more posts on this in the coming days.
Update II: As promised here is the post exploring why the US stimulus worked where the Spanish stimulus did not.