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According to the Congressional Budget Office, this year's fiscal deficit is expected to come in well below the record $1.41 trillion reached in the 2009 budget year. For the first 10 months, this year's fiscal deficit is also smaller than that of last year. Revenues increased by $140 billion while outlay rose by $74 billion. The federal budget deficit was about $1.1 trillion in the first 10 months of fiscal year 2011, CBO estimates — $66 billion less than during the same period a year ago. Revenues were about 8 percent higher than they were at the same point last year, whereas outlays rose by less than 3 percent.

With modest economic growth and some inflation, as a percentage of the GDP, this year's rate is considerably lower than that in 2009, probably ending up at just 8.5% as compared with just below 10% then, according to the CBO. The signs are that the deficit ratio will end up closer to 8% than to 8.5%.

With all this improvement, it is strange that the two contending parties in Congress had to fight to work out an agreeable austerity deal so that the debt ceiling could be increased. After all, no one would expect that the budget could be balanced immediately with an economy struggling to recover from the most serious recession seen in decades. Any deficit will add to the debt and will require a raise in the debt ceiling.

Meanwhile, President Obama is worrying about weak job growth. However, with both federal and state governments slashing jobs, some half a million since the economic recovery began in 2009, it is inevitable that total job growth will be weak. If the employment multiplier effect was 2, the austerity measures had cost the economy a million jobs in all. Weaker economic and job growth also meant less revenue. Jioseph Eugene Stiglitz argued recently that spending to boost jobs will ultimately reduce the debt since “our tax revenues will increase enormously.”

With fiscal “stimulus” being negative, corporations from the US to Japan to Europe are now sitting on piles of cash rather than investing. That is the effect of psychology, the importance of which economists from John Maynard Keynes to Hyman Philip Minsky to Robert James "Bob" Shiller have reminded us. But as argued by Bradford Delong, this is something we have somehow learned to forget.

With fiscal policy in reverse gear, Ben Shalom Bernanke had gone from QE1 to QE2 and may be forced to provide another round of monetary stimulus. That is helping to create bubbles of all kinds: Commodity bubbles, and real estate bubbles (in Hong Kong, mainland China, India, Australia, and Brazil, etc.).

We are going from one extreme to another extreme. In the early 1980s, it was excessively tight monetary policy and excessively expansionary fiscal policy under Ronald Reagan that caused the big jump in fiscal deficits. Now we are going through a prolonged period of excessively loose monetary policy and excessive, tight fiscal policy. The worry is that the tight fiscal policy will inadvertently keep monetary policy too expansionary for too long.

The decision by various governments to cut spending regardless of the cost is very “uneconomic” because it is irrational. Spending that brings more social benefit than cost should not be cut. But the politicians are now dumping the basic principle of economics, and the economy and society are suffering. Just consider the possibilities: What if, in cutting spending, such infrastructure as roads and bridges are poorly maintained leading to disasters; a humanitarian crisis occurs in America and food and shelter become a problem for tens or hundreds of thousands of Americans; and/or more Americans cannot afford college and become high school dropouts?

As pointed out by Martin Wolf in a July 13 article in the Financial Times (not linked):

The astonishing feature of the federal fiscal position is that revenues are forecast to be a mere 14.4 percent of GDP in 2011, far below their postwar average of close to 18 percent. Individual income tax is forecast to be a mere 6.3 percent of GDP in 2011 .… [I]n 1988, at the end of Ronald Reagan’s term, receipts were 18.2 percent of GDP.

We need to remember that the recession of 1937 -- the second dip after recovering from the Great Depression -- was a direct result of excessive fiscal austerity. We need to learn from history and to have better economic sense.

Source: Extreme Fiscal Austerity Must Be Avoided