Think big deficits cause recessions?
Think again!

BY

FREDERICK C. THAYER

 

 

The chairman of the Republican National Committee predicts that a recession is on the way, blaming the usual suspects - deficits, regulations and taxes. His prediction is probably correct, but his reasoning is not. The culprit is very probably the recent reductions in the federal deficit as a percentage of Gross Domestic Product. The record of history is totally at odds with economic principles and textbooks.

The annual deficit (spending minus revenues) has dropped from 4.9 to 2.3 percent of GDP since 1992.

This is the same pattern that immediately preceded the recession of 1990-91 that became a campaign issue in 1992.

The "recovery" that had begun in 1991 was not all that evident by mid-1992. Indeed, the beginning and end of "official" recessions can only be identified long after the fact.

Technically, recession occurs when the economy experiences negative economic growth for two quarters (six months). It then takes some time for the National Bureau of Economic Research to collect data and announce the beginning or end, a process that can take a year or more. If recession begins this year, we will know for sure only well into 1997, but the immediate effects will be quite visible.

I am not an economic forecaster, but I have uncovered unusual relationships that connect reductions in the national debt with major economic depressions, rising annual deficits with economic growth, and reduced annual deficits with economic contraction and recessions.

The record of history is clear and wholly consistent. Increases in the national debt and annual deficits never have harmed the economy, always have helped it. Significant reductions in the debt and the deficits never have helped, always have hurt. The record divides itself into two periods.

From the origins to World War II

In its first 150 years, the government periodically undertook systematic multi-year reductions in the national debt by taking in more revenues than it spent.

Each of six such sustained periods led to one of the six major depressions in our history. The last three of these crashes were the truly significant depressions of the industrial era.

This is the record:

1. 1817-21: In five years, the national debt was reduced by 29 percent, to $90 million. A depression began in 1819.

2. 1823-36: In 14 years, the debt was reduced by 99.7 percent, to $38,000. A depression began in 1837.

3. 1852-57: In six years, the debt was reduced by 59 percent, to $28.7 million. A depression began in 1857..

4. 1867-73: In seven years, the debt was reduced by 27 percent, to $2.2 billion. A depression began in 1873.

5. 1880-93: In 14 years, the debt was reduced by 57 percent, to $1 billion. A depression began in 1893.

6. 1920-30: In 11 years, the debt was reduced by 36 percent, to $16.2 billion. A depression began in 1929.

There have been no such multiyear budget surpluses and debt reductions since World War II and, significantly, no major new depression. The record suggests that reducing the debt never sustained prosperity, even when the debt was virtually wiped out by 1836. The highest deficits were those of world War II, ranging from 20 to 31 percent of Gross National Product. For a few years following the war, the debt was greater than GNP, the only such case in history. The wartime borrowing and spending actually ended the Great Depression.

Post-World War II

Both political parties pledge to balance the budget by 2002, and all budget-balancers hope ultimately to reduce the national debt. In the meantime, the nine recessions of the depression-free postwar decades have each followed reductions in the annual deficits relative to GDP.

Using data developed by Warren B. Mosler, economic analyst for a Florida investment firm, I suggest how some of the recent recessions have been politically significant:

· Deficit reductions, 1971-74, led to the recession that began at the end of 1973; a slow recovery did not help Gerald Ford in 1976.

· Deficit reductions, 1977-80, gave way to a recession in 1980 that damaged Jimmy Carter’s re-election hopes.

· Deficit reductions, 1987-89, were followed by the 1990-91 recession that harmed George Bush.

Meanwhile, the longest period without a recession was from November, 1982 to July, 1990.

The Republicans who now praise that "Reagan boom" never refer to the deficits or blame the Democratic Congress, while Democrats repeatedly attack "Reagan deficits." Neither side seems aware that a steep rise in deficits began in 1981, preceding the "boom" by almost two years.

When deficit reductions finally began in 1987, they paved the way for the next recession. Political irony is everywhere.

When the economy slides downhill, the incumbent president is badly damaged, and it does him little good to proclaim "success" in reducing deficits.

Ronald Reagan suffered no political harm because of the deficits of the 1980s and, even at his advanced age, might have been elected again in 1988 if he had been permitted to run. Whatever citizens say to pollsters, they vote against recessions, not budget deficits.

Driven by what appears to be wholly fallacious economic principles, politicians have put together such monstrosities as the Gramm-Rudman-Hollins deficit-reduction policy and the more recent "zero-sum budgeting" (all new programs must be financed by cuts in existing programs), along with the Clinton administration’s "reinvention of government" ("downsizing") to virtually guarantee a new economic disaster, perhaps more serious than any in recent decades.

Extreme danger ahead?

Europe as a whole has been in deep economic trouble for some time, and even Germany now has 11 percent unemployment.

Following the Maastricht criteria the prerequisites for monetary union, European countries are attempting to reduce their annual deficits to the less than 3 percent levels required by the treaty.

There is reason to believe that this effort is hurting European economies which, along with Japan and this country, cannot sell as many consumer goods and services as they need and wish to sell. A spreading recession virus could be very dangerous indeed.

The relationships outlined above deserve serious study, even if they are wholly foreign to widely accepted economic principle that blind even sophisticated analysts to such possibilities. It may be time to question what has been considered unquestionable principle.