Budgeting for Recovery The need to increase the federal deficit to revise a weak economy Published 6 January 2010 Written by Josh Bivens of the Economic Policy Institute Presented by Engr. Hasan AlSayegh Special Topics in Economic Policy 14 November 2011 Dr. Nayef Al-Shammari

Introduction (US Economy)  Eight (8) million jobs lost since Dec  Unemployment highest in 26 years  Recession over but profound weakness in job market  View point that “federal deficit is harmful to economy and must be avoided” is prevalent, which is wrong  “When workers and plants are idle and offices are empty, and when investment funds are begging to be borrowed, this is the time of deficits.”  “The obstacle for strong action on creating jobs posed by deficits is strictly political, not economic.”

 Paper examines relationship between:  Federal deficits, Interest rates, Inflation, International indebtedness, Generational equity  When there are idle resources in labor & capital markets, and interest rates at or near zero:  NONE of negative outcomes feared from running larger deficits will happen  Biggest threat is deficit will not be big enough for economy  American Recovery & Reinvestment Act (ARRA – 2009)  Small impact on overall budget deficit; short & long term  Long-run deficit impacted by Medicare, Medicaid  Need to reform for long-run budget balance  Past year & half: no reliance from US foreigners to finance government deficit  Private domestic savings increased faster than gov’t. borrowing: domestic residents holding public debt

US Budget Deficit Defined  Deficit occurs when federal government spending is greater than revenue in a given year  To finance deficit, gov’t. borrows by selling bonds  US federal spending dominated by social security, Medicare & Medicaid, defense spending, interest on debt  All other spending accounts for 15% of overall budget!  US federal revenue: federal income taxes, social insurance taxes, payroll taxes

Causes of Current Deficits  Q: How much of deficits (total debt) are due to policies of the Obama administration?  A: Very little  Changes to budget occur from  1) Policy changes  2) Changes in economic conditions  Cites work by Auerbach and Gale (2009), and Irons, Edwards, and Turner (2009), resulting in:  Most of deterioration in budget balance between 2001 and 2008 due to policy changes by Bush administration, not economic conditions  In 2009, deterioration of economy explains large increase in deficit for 2009

Economic Expansion of  CBO forecast in 2001: federal budget balance improve by ~$300 billion per year between 2001 and 2007; surplus to be ~$573 billion in 2007  Instead, budget was always in deficit; 2007: $161 billion  Represented $736 billion decline relative to original forecast  Decline explained by policy changes, not slow econ. growth:  Tax cuts; explain half of policy-driven declines in budget bal.  Increased defense and security spending (incl. Iraq, Afghanistan)  New Medicare prescription drug benefit (created with no revenue source)

2008: First Year of Recession 2008 deficit = $459 billion (increase of $298 billion from 2007) $160 billion was first stimulus package $100 billion in tax cuts to households $60 billion in tax cuts for businesses  $71 billion of $298 billion increase in deficit was attributed to overall economic weakness  By end of 2008, the difference between actual deficit and CBO 2001 projection was $1,091 billion

2009: Economy Implodes  Between January 2008 and August 2009, baseline CBO deficit projection increased by $1,380 billion  $778 billion from changing economic conditions  Less than a third of remaining $600 billion due to ARRA exp  Remember: $2.3 trillion difference between the large surplus projected in 2001 by the CBO for 2009 and the large deficit for 2009 is still mostly a function of policy changes instituted over that time period  They contributed $1.4 trillion to this change

Role of Recovery Act in Rising Deficits  Rise in deficit in 2009 caused by ARRA ($181 billion) less than 25% of decline caused by worsening economy  Thus, in near term, people concerned with large deficits should support policies to boost ailing economy to:  Reduce mechanical loss of tax revenue  Limit rise in safety net spending  Recovery Act designed to wind down quickly after 2011  Not an issue over the long-run deficit

Impact of Bailouts on Budget, Deficit  Rescue by government of insured and non-insured financial institutions, support for automakers, affect the budget, deficit, debt in complicated ways  Troubled Assets Relief Program (TARP): $700 billion  CBO expects most to be repaid, remainder calculated as part of deficit  BUT, full gross cost of TARP interventions is calculated in public debt  Nationalization of Fannie Mae, Freddie Mac adds more to annual deficit than to national debt  Government issued no new debt to acquire them  Declared them insolvent, put them into conservatorship  Cost of guaranteeing liabilities of bonds adds to deficit

Impact of Bailouts on Budget, Deficit  Bailouts have provided valuable subsidies to those receiving them  CBO estimates over a third of TARP will be pure subsidy to financial institutions, added significantly to short-term budget deficit  Benefits to economy are less clear than benefits by Recovery Act  But, these interventions not expected to be ongoing  Little impact on the long-run budget

Source: CBO – November 2011 Monthly Budget Review