LECTURE 15. RECESSION & RECOVERY

For a deeper understanding of the collapse and the problems 
of recovery than we can provide, read this  and this.

This lecture consists of a combination of direct 
quotations, paraphrasing, and slight additions to the work 
of Scott Fullwiler, Randall Wray, and others at the "New 
Economic Perspectives" blog.
RECESSION
Now that we have the accounting model (Lecture 3), we can 
understand the recession. The three balances (Private, 
Government, and Export surpluses) must balance to zero. 
This implies that it is impossible to change one of the 
balances without having a change in at least one other.  
Just remember that, with little change in net exports, a 
government budget deficit is a surplus for the private 
sector and a government budget surplus is a deficit for the 
private sector.

The facts are as follows:
Since the advent of offshore tax deferrals signed into law 
in 1976 by President Gerald Ford, the US manufacturing 
industry has been hollowed out to a shell of its heyday. A 
corporation would be foolish to operate a domestic plant 
when taxes and labor costs are less elsewhere. The result 
is the deterioration of the middle class and three decades 
of consumer borrowing.  Eventually the private sector 
became a net borrower.
 
Borrowing by the private sector allowed both the Clinton 
boom and the 2000s boom and caused the government budget 
deficit to fall (and to actually move into a large surplus 
during the Clinton years). 

The expansion before the global financial collapse (GFC) 
had been led (mostly) by the 2000s housing boom, during 
which households borrowed (and spent) on an unprecedented 
scale. In the Clinton boom, about half the deficit spending 
was by firms; however in the 2000s boom it was entirely the 
household sector that spent more than its income.

In 2005, tax revenues were growing much faster than both 
government spending and GDP growth. Thus, the private sector
was forced further into debt. Such fiscal tightening (called
fiscal drag) often is followed by a downturn — and the
downturn that accompanied the GFC was no exception.

The GFC was triggered by private sector debt but the 
collapse was due to deregulation and non-regulation of the 
finance, insurance, and rating industries.

When the GFC came, the federal budget deficits increased, 
mostly automatically. While government consumption 
expenditures  remained flat over the downturn , the rate of 
growth of tax revenues dropped sharply from a 5% growth 
rate to a 10% negative growth rate over just three quarters 
(from Q 4 of 2007 to Q 2 of 2008), reaching another low of 
-15% in Q1 of 2009.

Transfer payments (unemployment and other benefits) grew at 
an average rate of 10% since 2007. Decreasing taxes coupled 
with increased transfer payments automatically pushed the 
federal budget into a larger deficit, notwithstanding the 
flat consumption expenditures. 

As the economy slowed, the federal budget automatically 
went into a deficit, putting a floor under private demand. 
With countercyclical spending and cyclical tax reduction, 
the government’s budget acts as a powerful automatic 
stabilizer: deficits increase sharply in a downturn.  This 
helps the private sector.

The automatic stabilizer – more than the bailouts and 
stimulus—are the main reasons why the economy did not go 
into a free fall as it had in the Great Depression of the 
1930s.  The private sector had more money to spend.
RECOVERY
Since the crash, the household sector has retrenched, and 
saving remains high. The result is low demand, slow growth, 
and a rapidly growing budget deficit.
The Government Sector
The national conversation presumes that government budget 
deficits are discretionary (i.e, subject to control by 
policy). If only the government were to try hard enough, it 
could slash its deficit.  But shrinking the government’s 
deficit will require either that the private sector spend 
more relative to its income or that the US net export 
deficit fall sharply. But households are still heavily 
indebted and indeed more and more homeowners are falling 
“underwater”—so the likelihood that they will drop saving 
back down to the 2-3% range we saw in the 2000s seems 
unlikely.
 
At the aggregate level, government spending (mostly) 
determines private sector income. A sector can spend more 
than its income, but that means another spends less. While 
we can take government spending as more-or-less 
discretionary, government tax revenue depends largely on 
economic performance. Government cannot decide what its tax 
revenue will be because we apply a tax rate to variables 
like income and wealth that are outside government control.

And that means the budgetary outcome — whether surplus, 
balanced, or deficit — is not really discretionary.
The Private Sector
We could hope for a domestic private business sector boom 
but that is unlikely. With high unemployment, depressed 
domestic demand, and stagnant sales, investment by firms is 
not going to grow that much. Investment-led booms are 
really residential housing investment booms and there is 
little chance that we will see a housing construction boom 
in the near future.
The Foreign Sector
The final possibility is the foreign sector. Imports are 
running around 18% of GDP (rebounding sharply since the 
GFC) and exports are at 14% of GDP—so exports are up, but 
imports are climbing a bit faster (this difference is 
mostly due to oil). While it is true that the US net export 
balance has become less negative in recent months, much 
more movement will be required to actually get to positive 
territory (more than 3% of GDP of adjustment would be 
required). Note that the last time we actually had a 
positive net export balance was in the Bush (41) recession
—two decades ago.

Exports are largely outside control of the US.  (US efforts 
to increase exports will almost certainly lead to responses 
abroad).  It is true that economic outcomes in the US can 
influence exports — but impacts of policy on exports are 
weak. 

On the other hand, US imports depend largely on US income; 
if the US tried to reduce imports this would almost 
certainly lead to responses by trading partners that are 
pursuing trade-led growth.  Imports are largely pro-
cyclical, too. Again, our net export outcome—whether 
deficit, surplus, or balanced — is also largely 
non-discretionary.

Remember, to reduce the government sector deficit from the 
current 9% or so of GDP toward balance will require some 
combination of a private sector movement toward deficit and 
a net export movement toward surplus amounting to a total 
of 9% points of GDP. That is huge. The problem is that 
actually trying to balance the budget through spending cuts 
or tax increases could reduce economic growth. Lower 
economic growth could conceivably reduce our net export 
deficit—by making Americans too poor to buy imports, by 
lowering US wages and prices to make our exports more 
competitive, and by reducing the value of the dollar. Note 
that all of those are painful adjustments for Americans. 
And it might not work, because it requires the US to slow 
without that affecting the global economy—if it also slows, 
US exports will not increase. 
The Way Out
What is discretionary? Domestic spending — by households, 
firms, and government—is largely discretionary. And 
spending largely determines our income.
It makes most sense to promote spending that will utilize 
domestic resources close to capacity, and then let 
sectorial balances fall where they may. As we will argue 
further, the best domestic policy is to pursue full 
employment and price stability—not to target arbitrary 
government deficit or debt limits, which are mostly 
non-discretionary, anyway.
The Alternative to Full Employment
The current unemployment rate is about 9%. With a poulation 
of 300 million and a population growth rate reaching toward 
1%, we need to add 115,000 jobs/month to avoid a higher 
unemployment rate. With our present rate of GDP growth, the
following is the expected result:

To lower the unemployment rate to 8% within 2 years,
we would need to add 191,000 jobs/month.

To lower the unemployment rate to 7% within 3 years,
we would need to add 208,000 jobs/month.

To lower the unemployment rate to 6% within 4 years,
we would need to add 216,000 jobs/month.

Over the last 50 years, we have added an average of 125,000 
jobs/month and have rarely exceeded 200,000 jobs/month, 
even with a strong manufacturing industry and housing booms 
and without Asian and Brazilian competition.

Think about the future of children without a policy of
full employment.
Proceed to:
Lecture 16. EVALUATION OF THE STIMULUS
Thanks for your interest.
  Marvin Sussman, retired engineer

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