More on Debts and Deficits

In my earlier post I commented on how many people confused the debt and the deficit. Rick Perry, never known for being the brightest tool in the shed, does so here. But I would hope most of my readers are a lot smarter than he.

But I also wish to make a further point about the deficit. We hear all of this talk about a balanced budget but no one ever explains why this is a good idea. Even households rarely balance their budgets. As I explained last time, the important number is the amount of debt as a percentage of GDP. This is analogous to saying that rich people can afford to borrow more than less affluent people, something that should be self evident. In the normal course of events, the GDP increases every year. If the GDP doesn't increase and instead decreases, we call this a recession and we all know this is not good. There are many factors why GDP increases, not least that the population increases, either by childbirth or by immigration. As a result there are more people working, more consumers, more people needing cars and houses, etc. So if GDP rises from one year to the next, it stands to reason that the debt can increase by the same percentage and still maintain the same debt to GDP ratio. Viewed simplistically, if the GDP increases by x% then it is reasonable to increase the debt by x% to maintain the same Debt to GDP ratio. That increase in the debt means that the deficit in that year can be x% of the initial debt. In practical terms that means that, at current values we can run deficits of about $450B per year without increasing the debt to GDP ratio.

Even minimum thought leads one to the conclusion that by far the easiest way to solve the "deficit problem" is to increase GDP. GDP is currently growing at around 2% in spite of the efforts of Congress to derail the recovery. Had we had a robust stimulus package, not laid off al the teachers and firefighters and police around the country, the economy might now be growing at 4% per year and we would be well on our way to solving the problem.

Sadly, the chances of Congress being reasonable any time soon are somewhere south of none, by which I mean they are far more likely to hurt rather than help the economy. I cite the current sequester as evidence.