Why Deficit Reduction Is The Wrong Medicine For Recession

We usually talk about the national debt in relation to national income. This is usually expressed as the debt to GDP ratio. The ratio can be lowered by cutting the debt, by increasing GDP or doing both. This article explains why it is a bad idea to focus on debt reduction in a recession. Government spending is part of GDP. When we cut government spending in a recession it reduces debt but it also reduces GDP unless there is growth in the other components of GDP. Since consumer spending and business investment are not growing during a recession, this causes the debt to GDP ratio to increase. In a growing economy it makes sense to cut the ratio by lowering spending and raising taxes. That is what happened in the Clinton administration. Growth in GDP led to budget surpluses and lowered the debt to GDP ratio.

Some deficit hawks claim that fiscal austerity will increase business confidence and business spending which will cause the economy to grow. There is little evidence to support this concept of expansionary austerity. We are seeing the opposite in those countries where it is being attempted. The success of the deficit hawks in the ongoing debate is more closely related to moral values. We view saving as a virtue and excessive spending as a vice.