Budget Deal Is A Victory For Deficit Hawks, Loss For Economy

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by: Ed Dolan

A proposed budget deal brokered by Senator Patty Murray and Representative Paul Ryan is headed for the Senate after passing the House on a bipartisan vote Thursday. Not everyone is happy about it. Conservatives would have liked to see more new deficit cutting measures. "In the coming days, members of Congress will have to explain to their constituents what exactly they achieved by increasing spending, increasing fees and offering up another round of promises waiting to be broken," grumbled Michael Needham of Heritage Action. Many liberals are unhappy with the deal, too. "Here we are still having the conversation about how to cut government instead of how to improve the prospects of the long-term unemployed and improve the overall economy, which would take expanding spending, not shrinking it," economist Laura Dresser lamented to The Progressive.

With both the right and the left denouncing the deal, who is the real winner? If we look at the numbers, it is hard not to conclude that the pending deal, which would lock in the status quo, is a victory for the deficit hawks who have pretty much had their way with fiscal policy in recent years. True, on the downslope of the recession, first the Bush and then the Obama administrations tried fiscal stimulus. Without their actions, the downturn would very likely have been even deeper. However, the stimulus has long since run its course. Since the recovery officially began in mid-2009, fiscal policy has tightened markedly.

Some people evidently don't believe that. The Tea Party News Network, for example, continues to rant about "years marked by runaway spending and out-of-control deficits," but those years ended some time ago. To see what has really been going on, we need to take a closer look at the evolution of fiscal policy over the course of the Great Recession and the still-incomplete recovery from it.

The broadest indicator of the stance of fiscal policy is the primary structural balance (PSB)-the government's surplus or deficit adjusted to strip away the impact both of the business cycle and of interest payments on past debts. The orthodox view is that the PSB should show a slight surplus, on average, over the business cycle, with the size of the appropriate surplus depending on interest rates, the rate of economic growth, and the level of the deficit accumulated in the past. Using the PSB as a benchmark, we can identify three possible patterns of fiscal policy:

  • If the PSB is constant over the course of the business cycle, the actual budget will move into deficit when the economy dips into recession and into a larger than normal surplus during a boom. That pattern of policy is cyclically neutral.
  • A countercyclical fiscal policy attempts to smooth the business cycle by using discretionary tax cuts or spending increases to move the PSB toward deficit during a recession, and by using tax increases and spending cuts to prevent overheating during a boom.
  • A procyclical fiscal policy amplifies the business cycle rather than smoothing it. It does so by using tax cuts and spending increases to move the PSB toward surplus when the economy is operating below potential and then cutting taxes and increasing spending in times of prosperity.

As the following chart shows, U.S. fiscal policy since 2009 has been distinctly procyclical. The line labeled "output gap" measures the amount by which the economy is above or below its potential level of real output, that is, the level needed to achieve full employment, now thought to be something around 6 percent for the United States. Despite the large negative output gap, fiscal policy has steadily tightened since 2009, as shown by the movement of the PSB toward surplus. The points for 2014 and 2015, which show further movement toward surplus, are estimates based on the assumption that fiscal policy would follow the path set by existing law. They were made before the recent budget agreement was proposed, but since the deal focuses on details of spending and revenue with little or no effect on the overall budget balance, those estimates are unaffected.

Output gaps and primary structural balances may strike some readers as excessively abstract concepts, so let's look at a couple of additional charts that underline the degree of fiscal austerity over the past four years.

The first of these shows the government sector's contribution to GDP growth. The federal contribution has been negative in ten out of the last twelve quarters, reinforced-- in most of them-- by further budget tightening on the state and local levels. In plain English, fiscal austerity has made a slow recovery even slower than it would otherwise have been.

The next chart shows the share of federal workers in the civilian labor force, another common-sense measure of the size of government. Since the peak of the 2009 stimulus and the end of temporary hiring for the 2010 census, the path of federal employment has been steadily downward. It is now lower than the lowest level reached during the Bush administration.

The bottom line: Although it is being sold as a pragmatic centrist compromise, the Murray-Ryan budget deal, which locks in the pattern of procyclical fiscal austerity established over the past four years, is a victory for deficit hawks. Unfortunately, it is less of one for the economy, since efforts to shrink the deficit during a period of weak demand and elevated unemployment inevitably slow the recovery.