OK, all my students: quit gravedigging old threads and read this one, mmmkay?
I saw a version of that chart in this article by John Mauldin. I strongly recommend you read it. He takes Macroeconomics 101 and uses it to examine our current situation. His conclusion: even the Obama projections of future deficits are not a good thing.
There are some areas where he has to take Macro 101 to task: we have to teach that there is a GDP Multiplier equal to 1/(1-MPC), where MPC is the Marginal Propensity to Consume. It’s a fancy little equation, but essentially worthless in the long run. In the long run, you see, the GDP Multiplier is zero.
“This means there is no long term income benefit from stimulus programs. According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time.” – Robert Barro
Taxes have to go up in order to meet federal spending obligations, which include making interest payments on the debt. Those tax increases are going to drag the economy downward, and that’s just one influence, at the end a lot of people will need extra help from companies like the CreditAssociates. There really isn’t any argument on the GDP Multiplier being 0 in the long run – both the President’s Council of Economic Advisors and many other economists agree on that fact. It’s a short-term goose to the economy that will flatten out over time. Japan’s 20 years of huge deficits and flat growth are testament to that.
Now, in order for the government to borrow this huge amount of money to make GDP look nice in the short run, it has to find lenders. When it attracts lenders, it is pulling them away from offering loanable funds to firms that are looking to make capital investments. That’s the AP Economics phrase. The shorter version is that the government is “crowding out” investment, which keeps it from going to businesses that are looking to grow themselves. That means we’ll have a reduction in total growth.
If you look at the deficit this year, $400 billion of its funding came from foreign lenders. The rest came from domestic banks that are too scared to lend to any entity other than the USG. Small and medium businesses are unable to borrow money to keep things going, and are having to shut their doors.
Commercial property values continue to decline, so banks are going to be getting out of that market, with harsh results for businesses, as banks underwrite 45% of all commercial property loans. As they leave that market, those small and medium businesses are going to have to keep using the garage – or go back to it – and their hoped-for jobs will not come into existence.
So we’re already looking at a lack of stimulus to demand. In Macro 101 terms, that means the aggregate demand curve stays where it is or drifts further to the left, deeper into recession territory. Another Macro 101 concept is that raising taxes will reduce demand. Because most states have to balance their budgets, they’ve already been raising taxes. That’s one drag on the economy. Congress is going to raise taxes in 2011 by letting the Bush-era tax cuts expire. That’s going to be another big drag on the economy. (For the older folks, I’m not referring to Don Rickles in “Bikini Beach.”)
The hard truth is that we’re looking at some long-run changes in the economy. Here it is in Macro 101 terms: The Long Run Phillips Curve is shifting to the right – that means a higher natural rate of unemployment. What we think of as recessionary now will look passably good in a few years. The LRPC’s short-run cousin may also shift to the right as we become used to more and more government printing of money. The Aggregate Supply curve will not be growing as much as it did in the past. That’s going to mean less increase in the LRAS and the Production-Possibility Frontier. If more businesses close their doors and more banks fail, we may see actual shrinkage in those areas if productive capacity does not at least replace depreciating capital. The government is trying to boost AD to get things rolling again, but increases in taxes are canceling out a big chunk of that boost. Moreover, the fact that the government has to borrow so much money is leaving hardly anything for firms to borrow, which limits their ability to boost demand with more investment spending.
That’s just with what we have on the table right now. If we were to see shocks in commodity prices – particularly petroleum – we’d watch as prices went up along with unemployment as AS shifts leftward towards stagflation. Then again, we could also have a deflationary bank collapse hit at the same time so that prices stay normal, but we have even more job losses – hardly a reason to celebrate.
What gets me the most is that I can teach this to my Economics students RIGHT NOW and they can get the big picture. There are people with advanced degrees in Economics that think they can somehow calculate their way around reality that are trying to say we’re in a recovery and on our way to happy days again. Folks, when something is too good to be true, it is. The key lesson in Macro 101 is that everything has its cost and there ain’t no such thing as a free lunch.
Get ready for the bill, kiddos. Get ready for the bill.