IN a very good op-ed yesterday on how the U.S. can get back to full employment without relying on speculative bubbles, the FED, or indulging our obsession with consumption. However, he created a little bit of a sir in the comments section with the following sentence:
With federal and state governments bent on continued or increased fiscal austerity, the fate of these unemployed seems likely to remain dire if alternative policies are not implemented.
The issue of U.S. austerity has been a hot topic in economic and political circles. As to the latter, I have no interest. As to the former, both Keynesians and Market Monetarists have been in a debate over which economic theory is being proven right during the recovery. Keynesians, such as Paul Krugman, argue that fiscal spending (coupled with some monetary and tax stimulus thrown in) is the best tool to push an economy out of a recession. Moreover, because of the U.S. government’s fiscal austerity measures, the recovery remains weak. Market Monetarists, such as Scott Sumner, argue that the FED and monetary policy is the best tool, and that because of the Federal Reserve’s easy money policies, the U.S. economy was able to overcome fiscal austerity and not experience a double dip recession like our European counterparts whose central banks have not relaxed monetary policy as much.
Competing theories but they both rely on the same premise: the U.S. has engaged in fiscal austerity. Most have accepted that premise as true. But is it? Below is a graph showing total federal spending (in nominal $), and total federal, state, and local spending (in nominal $):
There doesn’t appear to be any fiscal tightening. In nominal terms, spending has not decreased, and in fact continues to rise. Of course, Krugman has argued that the better way to measure government spending, and thus whether the U.S. is in an age of austerity, is to measure spending as a % of potential GDP, and gives us the following chart:
Somewhat convincing, but here’s the same graph beginning in 1960:
FGS/NPGDP is returning to the longer run levels of the 1970s, and more so the 1980s. (Of course, this assumes that potential GDP is an accurate measure). [EDIT: Here is U.S. federal expenditures as a % of total GDP. With spending constant, the decline in spending as a % is an indication of an expanding economy rather than fiscal austerity]:
[EDIT: So, in relation to the economy (measured by GDP), spending is decreasing, but that is not a function of austerity. Rather, it’s a function of an expanding economy. Some could interpret this as evidence of austerity if one believes that government spending should remain at a particular % of the total economy. However, as evidenced in the above chart showing government spending as a % of GDP, that % always increases during a recession as economic contract coupled with rises in government spending (automatic stabilizers such as unemployment benefits kick in) expand that number. As the economy begins to improve, and as those automatic stabilizers get phased out, then government spending as a % of GDP decreases. It’s the natural business cycles rather than some adoption by U.S. policymakers of austerity measures. Moreover, as noted above, this decline is bringing spending as a % of GDP back into line with the longer trend levels of the 1970s and 1980s.]
As an aside, despite the stagnant spending by the federal government, deficits have declined. However, the decline in the deficit in the face of rising spending is attributable to an increase in tax receipts:
But before anyone draws the conclusion that this is an indication taxes are out of control, the below graph shows U.S. federal tax receipts of nominal GDP: