The relationship between federal deficit spending and GDP growth

Those who do not understand (or who pretend not to understand) economics, repeatedly confuse federal finances with personal finances.

Those people decry the size of the federal deficits and debt as being “unsustainable,” which these measures would be if they were personal deficits and debt.

The federal government, being uniquely Monetarily Sovereign, never can run short of its sovereign currency, the U.S. dollar, so the government can “sustain” any size deficit and debt.

  1. Gross Domestic Product is a common measure of the economy
  2. Federal deficit spending adds dollars to the economy.
  3. Economic growth, by formula, requires growing dollar supplies:

GDP = Federal Spending + Non-federal Spending + Net Exports

If the deficit critics were correct, you would expect to see:

  • GDP reduction caused by deficit growth
  • GDP increases caused by deficit reduction
  • Recessions caused by deficit growth
  • Recessions cured by deficit reduction

Yet that is exactly the opposite of what you see.

Image result for great depression
Every depression in U.S. history has been caused by federal debt reduction*

 

*Historically, reduced deficits have caused recessions and even depressions. Increased deficit spending is necessary to cure recessions and depressions.

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1804-1812: U. S. Federal Debt reduced 48%. Depression began 1807.
1817-1821: U. S. Federal Debt reduced 29%. Depression began 1819.
1823-1836: U. S. Federal Debt reduced 99%. Depression began 1837.
1852-1857: U. S. Federal Debt reduced 59%. Depression began 1857.
1867-1873: U. S. Federal Debt reduced 27%. Depression began 1873.
1880-1893: U. S. Federal Debt reduced 57%. Depression began 1893.
1920-1930: U. S. Federal Debt reduced 36%. Depression began 1929.
1997-2001: U. S. Federal Debt reduced 15%. Recession began 2001.

The following graph compares the annual federal debt percentage changes (red line) which reflect deficits, vs. GDP percentage changes (blue line). The vertical bars are recessions.

What you do see is:

    • Reduced debt growth leads to recessions
    • Increased debt growth cures recessions
    • Increased debt growth leads to increased GDP growth

For clarity, let’s examine individual segments of the above graph:

Prior to 1974, federal deficits rose then fell, pulling GDP along with them. This reduced deficit spending precipitated the recession of 1974, which was cured by increased deficit growth through 1976.

The increased deficit growth precipitated increased GDP growth, with momentum carrying GDP through 1979, when it too began to fall.

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As a result of the long period of falling deficit growth, even the short upturn in the last quarter of 1979 could not save the economy, and the falling momentum of GDP resulted in the recession of 1980.

The increased deficit growth cured the recession, which ended in the 3rd quarter of 1980, when GDP turned up, and continued to be pulled up by more deficit growth.

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Continued, increasing deficit growth pulled GDP up, and even when deficit growth declined, in 1981, momentum pulled GDP upward.

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Yet again, you see that familiar pattern. Declining deficits lead to the recession of 1981, which growing deficits cure by the end of 1982.

Increasing deficits pull GDP upward, and even when deficit increases end in the 2nd Qtr of 1983, momentum continues to carry GDP upward.

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The enormous deficits of 1983 force powerful GDP growth momentum, which reverses as deficit growth continues to decline.

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And there again, the familiar pattern: Reduced deficit growth forcing down GDP growth, and even a short period of deficit growth increase cannot forestall the recession of 1990-1991.

And again, increased deficit growth cures the recession and turns GDP growth upward.

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As always, the predictable pattern:

  1. First, deficit growth pulls us out of a recession and forces GDP growth upward.
  2. Then, deficit growth tops out, but momentum carries GPD growth along for several years.
  3. Finally, GDP momentum yields to decreased deficit growth. (This time, we actually ran a federal surplus, which normally would cause a full-fledged depression. However, we were “fortunate,” and “only” suffered the recession of 2001.
  4. Then, as always, it took increased federal deficit spending to pull us out of the recession in 2002.

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And here we go again: Massive deficit spending pulls us out of a recession; after escaping that disaster we begin again to cut deficit growth, then (in mid-2007) we increase deficit growth; but it’s too late, and we enter yet another recession; this one is the “Great Recession” of 2008.

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Now here we are, today. Huge deficit growth, having cured the recession, we continue not only those big deficits, but even grow them, first at 30% annually, finally leveling off at about 5% annual deficit growth — a big number, considering the size of the deficit.

This has caused GDP to average a robust average of about 4% annual growth.

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Despite all the incontrovertible data, the next time you open your newspaper, or watch you local federal finance TV “expert,” you will be told that the federal debt and/or deficit are (oh, horrors) at record highs, and are “unsustainable,” or a “ticking time bomb.”

It’s no coincidence that GDP is at record highs, too. Federal deficit spending lifted it there.

Rodger Malcolm Mitchell
Monetary Sovereignty
Twitter: @rodgermitchell
Search #monetarysovereignty Facebook: Rodger Malcolm Mitchell

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The most important problems in economics involve:

  1. Monetary Sovereignty describes money creation and destruction.
  2. Gap Psychology describes the common desire to distance oneself from those “below” in any socio-economic ranking, and to come nearer those “above.” The socio-economic distance is referred to as “The Gap.”

Wide Gaps negatively affect poverty, health and longevity, education, housing, law and crime, war, leadership, ownership, bigotry, supply and demand, taxation, GDP, international relations, scientific advancement, the environment, human motivation and well-being, and virtually every other issue in economics.

Implementation of Monetary Sovereignty and The Ten Steps To Prosperity can grow the economy and narrow the Gaps:

Ten Steps To Prosperity:

1. Eliminate FICA

2. Federally funded Medicare — parts A, B & D, plus long-term care — for everyone

3. Provide a monthly economic bonus to every man, woman and child in America (similar to social security for all)

4. Free education (including post-grad) for everyone

5. Salary for attending school

6. Eliminate federal taxes on business

7. Increase the standard income tax deduction, annually. 

8. Tax the very rich (the “.1%”) more, with higher progressive tax rates on all forms of income.

9. Federal ownership of all banks

10. Increase federal spending on the myriad initiatives that benefit America’s 99.9% 

The Ten Steps will grow the economy and narrow the income/wealth/power Gap between the rich and the rest.

MONETARY SOVEREIGNTY

17 thoughts on “The relationship between federal deficit spending and GDP growth

  1. Hello Rodger,

    Fedgov debt drives GDP with a 4 quarter lag, It comes out again and again in your excellent charts. Great post.

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  2. Very well-said, Rodger! Some will point to the exceptions such as the late 1940s and early 1950s postwar expansion in spite of running a federal “surplus” (due to both tax hikes and spending cuts), but they gloss over the fact that private-sector debt *exploded* during that time, which only temporarily masked the shortage of new growth dollars and kicked the can down the road. They ignore the fairly deep 1948 and 1955 deflationary recessions as well, and how when the postwar boom began running out of steam, “deficit” spending thus inevitably had to resume to keep it humming along.

    The other exception is the Canadian experience in the 1990s during which they experienced both austerity (federal “surplus”) and renewed economic growth simultaneously. Budget hawks even suggest the howler that the austerity *caused* the renewed growth. They don’t know (or pretend not to know) the crucial difference between “because of” and “in spite of”. What really happened is 1) their overly tight monetary policy was loosened in the early 1990s, and their overvalued currency thus devalued, and 2) private sector debt also increased to mask the harmful effects of austerity. And Canada of course benefited from the global economic boom during that time as well, particular when the USA was still boosting the global economy by running sizable “deficits” in 1992-1997 and thus pumping US dollars into it, thus offsetting the relative shrinkage of Canadian dollars.

    Thus, these exceptions only prove the rule.

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      1. Indeed, and much of the postwar boom (in spite of the postwar “surplus”) as well was due to the continued lagged effect of the massive “deficit” spending during WWII, until that ran out of steam and “deficit” spending ultimately resumed once again.

        Another example is Iceland. In the wake of their financial crisis in 2008, they actually implemented more austerity than any country not named Greece. But their recovery was indeed *in spite of* their austerity, NOT because of it. What really caused their recovery (and masked the effects of austerity) was when they devalued their overvalued currency, and instead of bailing out the banks they jailed the banksters and essentially bailed out the people instead and maintained a strong social safety net. And Iceland had a sizable “deficit” in 2005-2007 before their financial crisis that gave them some stimulus during the beginning of the crisis due to lag effects, and their “deficit” spending ultimately resumed in 2016 once again.

        https://countryeconomy.com/deficit/iceland

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        1. Right. GDP is a spending measure, and spending requires money.
          Austerity takes money from the economy. Generally, less money = less spending.
          This is not magic or rocket science.
          Unfortunately, the public does not understand the fundamental simplicity of Monetary Sovereignty. Perhaps playing a few games of Monopoly would help. There, the Bank cannot run out of Monopoly dollars, but the players can.

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          1. Indeed, the concept of Monetary Sovereignty is so simple, a child can understand it. Though it is apparently too complex for the “experts” and politicians to understand, especially since their salaries often depend on them NOT understanding it.

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        2. Actually, I read the Iceland chart above wrong, reversing the signs by mistake. Apparently, Iceland ran “surpluses” during 2005-2007 just before the financial crisis, which likely helped to cause that crisis. In contrast, they ran record-high “deficits” in 2008-2009 during their crisis (which helped cure it) before they really implemented their austerity from 2010 onwards, *after* the recovery began, and no “surpluses” again until 2016. So we see that the austerians’ argument is not only inaccurate, it is essentially 100% wrong.

          https://countryeconomy.com/deficit/iceland

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  3. Rodger, have you seen this book; “Utopia for Realists” by Rutger Bregman?
    I mention it because ,clinically speaking GDP measures spending and exports to arrive at a value of the economy. But GDP is very primitive as a measure of the overall economy. For example military spending is included but housework is not, unless you employ someone. Bregman goes into it in detail.
    So, ask your self is the economy doing well, All the GDP stats say that is correct, yet the reality is vastly different. In “Medium” Umair Haque explains that the USA is the richest poor country in the world;

    https://eand.co/if-the-economys-strong-why-are-40-of-americans-struggling-to-afford-food-934b13e6b81e

    Bregman makes the connection in his book.,Basically GDP works in wartime but not in today’s societies,with mostly service economies to measure. Also Economics did not exist 80 years ago as a profession.
    This all needs a rethink
    .Do you agree?

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    1. Thanks, John.

      I agree that GDP is a rough, overall approximation, that understates the economic situation for many and overstates for others.

      As you know, I consider the income/wealth/power Gaps between classes to be one of the most important measures, which the Gini index attempts to show, and which GDP does not address. Nor does GDP address health, education, crime, “happiness” and other social factors.

      The “10 Steps” are tilted toward narrowing the Gaps, but are not comprehensive.

      I use GDP data to refute the nonsense being disseminated about federal deficits and debt, but I recognize there is much more to people’s lives than a nation’s GDP..

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      1. Don’t forget the book! It’s right up your alley. He shows how well the UBI works with examples from the 18thCentury to now. So far I haven’t seen a mention of a job guarantee at all. Fascinating story how close Nixon came to setting one up.

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        1. I’m only slightly familiar with the book Utopia for Realists and it sounds good overall. Does the author support funding the UBI through new money creation (like Step #3 does) or through taxes? Does the author understand MS or at least MMT?

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          1. No there’s no mention that I have seen so far that he understands MMT. All the historical accounts are privately or government funded with taxes. the “local burghers” set aside funding for experiments, State governments too.
            The real issue with the schemes is that they all has opposition and were cut short or diverted of just not evaluated properly. It took determined efforts to ferret out the truth, which is that they all worked wonders. They all worked within the existing systems without the concept of MMT, or even Fiat money., which will make it so much simpler today, once people understand better.

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