A key metric in how well our (U.S.) economy is doing is GDP (Gross Domestic Product). The formula for GDP is:
GDP = C + I + G + Net Exports , where C is consumption, I is investment, G is government spending, and Net Exports is total exports - total imports.
To get a positive GDP, Net Exports has always been negative since 1977 because of our insistence on importing so much oil so C+I+G must increase to make up for the Net Exports. The sum of these three almost always will more than make up for the negative Net Exports although the trade deficit can be significant ($695.9 billion in 2007*). Now there is a move to try to eliminate or at least reduce Government deficits or reduce G (i.e. government spending in the formula). Therefore, C+I must increase more than the reduction in G plus a negative Net Exports in order to achieve a positive GDP. The bigger the reduction in G, the more difficult it will be for C+I to turn GDP positive.
Recently congress passed and the president signed a bill to cut the 2011 Federal budget by $38.5 billion in the last five months of the fiscal year.** If all these budget cuts were to occur this fiscal year as many wanted, to have a positive GDP over this period means that C and I must increase by more than $38.5 billion during these five months. I confess I have no idea how easy it would be for C+I to do this; however, consumption under the present depressed economic environment, where median household income is declining, is unlikely to increase much. So it falls mainly on investment to increase by most of the $38.5 billion.
It turns out, however, that only about $385 million of the $38.5 billion will occur in Fiscal Year 2011, and I would expect the economy to easily handle that. But the rest of the cuts are real though they will occur in future years and spreading them out like that should make them easier to handle especially if the economy continues to recover from the Great Recession.
There will be attempts to make even larger cuts in the Federal budget in future years so the impacts on GDP will be larger if they are instituted. Actually, the best time to cut the Federal budget significantly is during a rapidly rising economy when both C and I are rapidly increasing and not, as now, during a slow recovery from a Great Recession. Yes, declining G will lower the GDP by some amount during a rapidly expanding economy depending on the size of the Federal budget reduction and on how fast C+I are increasing.
I suspect that most people who want large budget cuts NOW (including nearly all "tea partiers" it would seem), do not understand the equation for GDP. There are those, however, that do (e.g. John Mauldin). With them, they feel that cutting the Federal budget will give a morale boost and help the economy. More specifically the expectation is that Federal borrowing drives out private sector borrowing because there is only so much money. This claim is faulty, however, in that no one forces industry to buy Treasury bonds, notes or bills. If they are doing it, it is because the don't know of anything better to do with the money and want to park it somewhere safe. In addition, the wealthy do not invest much of their money on productive things in America but put a lot of it voluntarily into government bonds (not all American Treasuries) and "... goes to things that may benefit the global economy but have no or little benefit to the U.S. - such as purchasing chalets in Switzerland, Canadian bombardier personal jets, islands in the Bahamas, and the like.*** As the amount of Treasuries are reduced, the wealthy will probably still buy them in their usual amounts because they want to put most of their money into safe securities rather than taking on more risk, though this may drive up the price of the bonds.
The point is that if reductions in the Federal budget are instituted too rapidly, investment and consumption may not be able to keep up and therefore plunge our GDP into negative numbers, thus creating a recession or worse. Our best hope is that the current economic recovery continues and even accelerates which would even make the size of the Federal budget reductions more manageable. After all, Federal revenues are the lowest they have been in 60 years.
* http://en.wikipedia.org/wiki/Economy_of_the_United_States
** http://stopcontinentaldrift.blogspot.com/2011/04/385-billion-is-lot-of-money.html
*** http://stopcontinentaldrift.blogspot.com/2010/05/effectiveness-of-taxes.html
No comments:
Post a Comment