Causes of Current Federal Deficit

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An article in the June 24 issue of the Westport Minuteman described Dan Debicella as saying “Jim Himes voting record has led to the $1.4 trillion [federal budget] deficit.”  Debicella also said the $800 billion stimulus package (American Recovery and Reinvestment Act) enacted in February 2009 was both unnecessary and ineffective, and Congressman Himes committed a grave error in voting for it.  Mr. Debicella proposes to repeal the act.  In blaming President Obama and Mr. Himes for the current deficit, Mr. Debicella apparently has a poor memory and a poor understanding of economics.

The article did not mention that President George W. Bush handed Barack Obama a federal budget deficit of $1.2 trillion in January 2009 as well as an economy declining more rapidly that at any time since the 1930s.  Economic stimulus was needed to stop the downward spiral caused by the impending collapse of the financial sector as well as the housing sector, which had not been adequately regulated during Republican control of all three branches of government, as well as the Federal Reserve.

The Great Recession started in December 2007, more than a year before Barack Obama and Jim Himes took office.  This recession was caused by failed Republican policies of deregulation and unfunded war.  (Remember how Bush saved us from Iraq’s weapons of mass destruction that did not exist?)  Congress funded TARP at the request of President Bush.  Hank Paulson, Treasury Secretary until 2009, has said that if Bush had not reversed course and funded the bank bailout and initiated the bailout of the auto industry, we would have had 20% unemployment.  President Obama and Jim Himes have been working tirelessly to fix the mess left by the Republicans.

It should be noted that it was a Democratic Administration that produced the only balanced federal budgets in a generation.  President Clinton inherited a large (for those days) budget deficit from President George H.W. Bush.  Proper Democratic Administration fiscal policy and Congressional Paygo rules produced budget surpluses during the last three years of Clinton’s second term, and there was serious talk of paying down the national debt to very low levels in preparation for the retirement of the baby boomer generation.  Although the recession of 2002-2003 would probably have led to a temporary budget deficit, we should have had a federal budget surplus again by 2005 if President George W. Bush had followed equally sound fiscal policies.  However, he was influenced by V.P. Dick Cheney, who said deficits did not matter.

Republican deregulatory policies wrecked the U.S. economy.  Alan Greenspan, appointed to the chairmanship of the Federal Reserve by President Reagan, followed the Republican deregulatory philosophy and urged people to take adjustable rate mortgages instead of fixed-rate mortgages with payments they could be sure they could afford.  When no down payment mortgages and liar loans were offered by mortgage brokers, Greenspan looked the other way and the Bush Administration asserted federal jurisdiction to prevent five state attorneys general from investigating the use of fraudulent and deceptive sales tactics by mortgage brokers.  This fueled the pipeline to Wall Street firms that created collateralized debt obligations and sold the CDOs to foreign banks, pension funds, etc., obscuring the risk involved in the inevitable downturn of the housing market.

In a June 2008 speech, President and CEO of the NY Federal Reserve Bank Timothy Geithner — who in 2009 became Secretary of the United States Treasury — placed significant blame for the freezing of credit markets on a “run” on the entities in the shadow banking system. These entities became critical to the credit markets underpinning the financial system, but were not subject to the same regulatory controls as banks. Further, these entities were vulnerable because of maturity mismatch, meaning that they borrowed short-term in liquid markets to purchase long-term, illiquid and risky assets. This meant that disruptions in credit markets would make them subject to rapid deleveraging, selling their long-term assets at depressed prices.

Paul Krugman, winner of the 1999 Nobel Prize in Economics, described the run on the shadow banking system as the “core of what happened” to cause the crisis.  A sudden drop in liquidity led to a sharp downward spiral in aggregate demand, and we started seeing 700,000 jobs lost every month.  It is well documented that the $800 billion stimulus package has created or saved between 2 million to 3 million jobs.  However, Prof. Krugman said in February 2009 that an $800 billion stimulus was not enough, and recent developments indicate that he may have been right.

In testimony to a Congressional committee investigating the causes of the financial crisis, Alan Greenspan admitted that there had been a flaw in his philosophy of financial market deregulation.  Essentially, the flaw was that financial markets do not regulate themselves as efficiently as he had assumed.

One of the lessons that we should have learned from the Great Depression is that early attempts to balance the budget will not work.  In general, premature attempts to balance a national budget will lead to an economic downturn.  The resulting downturn will reduce tax revenues, making it harder to balance the budget.  This is what happened in 1937, when political pressure forced President Roosevelt to reduce federal spending.  The net federal deficit was reduced almost 90% from 1936 to 1937.  The result was another severe recession.  In 1938, the deficit rebounded to 60% of its 1936 peak, not because of increased spending but because of reduced tax revenues.  Other countries have had similar experiences.

Joseph Stiglitz, another Nobel Prize-winning economist, has said that one of the many ironies that have marked the crisis is that Greenspan’s and Bush’s attempt to reduce the role of government has resulted in a large temporary increase in the government’s role in the economy.  Barack Obama and Jim Himes, like the main stream of the Democratic Party, are in favor of a well-regulated market economy.  As the economy recovers, the government will sell its stakes in CitiGroup, AIG, and General Motors.  Indeed, this has already started.  The Government will get most of its money back.

What we will not get back is the trillions of dollars of lost output from the idle capacity and millions of unemployed people.  That lost output is the result of the failed Republican policies, and a return to those laissez faire policies of the past 25 years would be a tragic mistake leading to even more lost output and misery for people who are out of work due to no fault of their own.  This tragic situation can only be remedied by increasing aggregate demand, and government will have to do its part.

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4 Responses to “Causes of Current Federal Deficit”

  1. ccdemuth Says:

    Building a new majority in the House of Representatives is the most direct route to bringing balance to a government that is spinning out of control on spending, taxes, and regulation. Jim Himes is part of the problem who consistently votes with Nancy Pelosi whenever she needs him. Dan Debicella is part of the solution because he is challenging a vulnerable freshman in a pivotal district in one of the most competitive election battles in the country. Whether or not you live and vote in Fairfield County, the vote in this district could have a big impact upon your family and your country.

    Dan has a different set of values – in his own words, he is running for Congress “to restore the values of free enterprise and individual liberty to Washington. Fairfield County families want practical solutions on the economy, healthcare, and transportation. I will use my background as a businessman and a State Senator to implement new ideas to get our economy growing again and create jobs for our families”.

    Over vocal opposition from voters, the current Congress has pushed measures that are making our country poorer, more vulnerable, and less free. It is time to push back. We If you are interested in learning more about Dan, check out his website:

    http://www.debicella.com

  2. MargotCT Says:

    This article was another attempt to convince readers that the current poor economic situation in the US was all Bush’s fault, without even mentioning that Democrats won majority in Congress in November 2006, and that Democratic majority Congress led by Pelosi for the past 4 years contributed to the current economic mess. According to the Gallup poll conducted on July 8-11, 2010, Congress approval rating was 11% – the lowest since the 70’s. Again, we are talking about the Democratic majority Congress. As for the deficit – in March 2010, the Congressional Budget Office (CBO) projected $1.5 trillion deficit for 2010 in Obama’s budget, while in 2008 deficit reached $455 billion. Do the math: $455 billion in 2008 (President Bush) vs. $1.5 trillion in 2010 (President Obama) – both working with Democratic majority Congress led by Nancy Pelosi. Also, Democrats, along with Democratic President, and having majority in both Houses, did not bother to pass the 2011 budget, in order to avoid exposing monstrous spending records. Himes’ voting records 95% aligned with Pelosi – Himes voted for both, $787 billion “Stimulus” and $450 billion “Omnibus” bills. Himes’ votes contributed to the $1.5 trillion deficit in the 2010 budget and $1.6 trillion deficit in the 2011 budget. Himes also voted for the Healthcare law which will result in at least $2.5 trillion entitlement spending over ten years, and which is very unpopular with the American people. In September 2003, when the Bush administration recommended the significant regulatory overhaul in the housing finance industry, which included revamping the oversight process over Freddie Mae and Freddie Mac, Barney Frank had been reasoning why the Financial reform of Fannie Mae and Freddie Mac was not needed. Frank said: “These two entities – Fannie Mae and Freddie Mac – are not facing any kind of financial crisis… ‘The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.” So why are we in this credit an economic mess now?
    Numbers and facts do not lie, and a voter is much more informed today than two years ago.

  3. floodingupeconomics Says:

    Its actually pretty simple… If we remember to distinguish between debt and deficit. A deficit is the yearly difference between expenditures and tax revenues.

    The current fiscal deficit was caused entirely by George Bush Jr. Check out this brief post to see exactly why: http://floodingupeconomics.wordpress.com/2010/11/28/how-bush-administration-policies-caused-the-fiscal-2015-budget-deficit/

    The debt is a separate issue which has little to do with the current presidency, and instead has to do with how much the government has run a deficit in the past. That really seems to have gotten out of control during the Reagan Administration.

    Cheers

  4. Nicholas Floren Says:

    Instead of the government shelling out more money for a bail out how about a little more security and freedom. The basic freedoms of more time with families, time off work to recover and refuel our bodies and minds.

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