The previously agreed federal budget cut of $85 billion this year, set to begin Friday, has renewed arguments over austerity vs. stimulus.
The current allegedly urgent question — whether this small reduction in federal spending will pitch the economy into a recession — suggests there is widespread misunderstanding of austerity and stimulus, or the scale of sums involved.
Stimulus and austerity are fairly simple and straightforward, as a look at how they work in the family budget shows.
A healthy family budget has neither. You spend only what you earn, after paying your bills and putting some money aside for emergencies, retirement and such.
Stimulus is when the family borrows money and spends it to produce a healthier financial situation in the future. For example, you might borrow at a favorable interest rate to improve the insulation and sealing of your home. The savings on the heating bill, after paying back the loan, leave more money available for spending thereafter.
Austerity is when the family must reduce its spending to less than its income, and use the difference to pay off loans so less income can be devoted to debt service in the future.
The same is true for nations, except that all spending beyond what’s collected in taxes is considered stimulus — not just financially beneficial spending such as infrastructure improvements — because it encourages economic activity by the recipients of the spending.
John Maynard Keynes, the famous advocate of stimulus to counter the Depression, said filling old bottles with money, burying them, and letting people organize and dig them up would work just fine as economic stimulus.
Thus the federal government has felt justified lavishing its stimulus spending on its political supporters, since from Keynes’ point of view that’s as good as most anything else.
That declared stimulus spending, called the American Recovery and Reinvestment Act of 2009, amounted to $831 billion.
But every dollar the federal government spends that it has borrowed, rather than raised by taxation, is stimulus.
The measure of stimulus spending, then, is the federal deficit, which was $1.3 trillion in fiscal year 2010, another $1.3 trillion in 2011, $1.1 trillion in 2012 and this year is expected to be $900 billion.
Even this is not all of the federal stimulus, because the Federal Reserve Bank is injecting $85 billion a month into the financial system.
Presumably we are about as stimulated as we can be, and yet the economy has limped along for many years, producing the occasional destructive asset bubble.
Our stimulus spending has put the federal government about $16.4 trillion dollars in debt, or about $50,000 for every American.
At some point, the federal government will have to pay off that debt by reducing spending below what it collects in taxes, just as a family puts its budget in order by reducing its spending to less than its income.
That would be austerity on the part of the federal government.
Now look again at the topic du jour, the $85 billion in previously agreed budget cuts.
This is less than a 10th of the federal stimulus spending taking place this year alone. And while it is a small reduction in the vast U.S. stimulation of the economy, it is several hundred billion dollars away from the first cent of actual austerity.
Economic stimulus, I think, has turned out to be similar in its effects as stimulant drugs.
Sure, in a pinch, a drug might keep you awake and give you the energy to deal with an emergency or get yourself out of a bad situation.
But soon more and more situations merit a stimulant, and the drugs don’t seem to work as well. In fact, they turn out to have side effects more damaging than the alleged benefit.
I think there is a place for economic stimulus: When the economy starts to recover because the conditions for growth are again in place, a focused and limited stimulus can give it the boost needed to ensure a robust rebound.
Lakshman Achuthan, the managing director of the Economic Cycle Research Institute, put it best, comparing the economic cycle to a swing.
“You don’t push a swing at any time you want. To get the desired result, you have to be ready to push and then, just when it’s at the right spot, you give it a push,” Achuthan said.
He told me that in November 2008, as the federal government was preparing its plans for trillions in stimulus spending.
My fear now is that we’ve become sort of addicted to stimulants, and withdrawal seems likely to be very unpleasant.
Contact Kevin Post: