It's a wonderful tradition to use Memorial Day to honor the memories of those soldiers who gave their lives to this great country. Unfortunately, we seem equally determined to use current economic policy to kill off what's left of our live civilian economy via insane fiscal austerity, as this NY Times piece illustrates.
The following graph is taken (via Bill Mitchell's blog) from the datasets available from the US Office of Management and Budget. They show the federal deficit, outlays and receipts as a percentage of GDP from 1930 to 2010. As Mitchell notes, history is not even being repeated at present. The fiscal expansion was nothing like that which occurred during the prosecution of the Second World War.
The reason the US economy grew again after the War is because the country did not go collectively mad and immediately enforce fiscal austerity to attack the financial ratios, despite the fact that the war raised the publicly held debt ratio well above the 90% threshold that Ken Rogoff and Carmen Reinhart keep warning us about. In the war years from 1941 to 1945, the GDP doubled while the national debt increased by more than 500 percent as Roosevelt financed much of the war expenditures through government borrowing. By the end of the war in 1945, the national debt had increased to $258 billion and was equal to approximately 120 percent of GDP.
Furthermore, in spite of the warnings issued in the Reinhart and Rogoff book, US growth in the postwar period was robust -- it was the golden age of US economic growth.
Sovereign debt is not a problem as long as the nation's debt contracts is denominated in the nation's currency -- and the nation has control over its own currency (in contrast to the euro zone). The Greek problem is the equivalent of the California problem, where California does not print its own currency.
The US managed the transition from war-time policy to peace-time policy via an acceptance of the (by then) Keynesian consensus that growth was dependent on demand and that the public deficit could underpin spending.
Growth reduced the public deficit as taxation receipts rose and spending could be wound down in an orderly manner relative to the growing size of the economy. Growth also saw the public debt ratio drop significantly. It also reduced the public debt ratio significantly during the 1940s and into the 1950s. There were no oppressive intergenerational burdens to be paid. The early baby boomers in the US and elsewhere enjoyed the growing prosperity of the peacetime 1950s. It was a time of optimism, not austerity.
Yes, I realize that there was pent-up demand from a war-based economy, but let's also not forget the role of the Marshall Plan, which represented a HUGE fiscal transfer (equivalent to around 2% of GDP) to Europe, in spite of the fact that we had these huge public deficits. Surprise, surprise, that "wasteful government spending" created huge new demand for US exports, which in turn helped to generate substantially higher rates of growth both in the US and western Europe.
There is no question that Obama's fiscal interventions were not managed as well as they might have been. For a start, they were too late and too frugal. They proceeded on the wrongheaded premise that if you got money to the banks, it would "unblock" the flow of credit to the economy and jump-start it again. The opposite is true: creditworthiness precedes credit. Far better would have been to introduce a Job Guarantee immediately to provide an unconditional buffer stock of jobs in every city and region to avoid the rapid rise in unemployment.
Far more should have been spent on public works programs, particularly with investment aimed at education, health, and (most importantly) renewable energy.
We should have put zero funds into the banking system -- all insolvent banks (including many of the "Big 6″) should have been shut down, the shareholders should have been wiped out and only then should the banks have been recapitalised. Somehow, fiscal austerity never seems to apply to our bloated financial system, which relies on a perpetual stream of government guarantees and massive financial subsidies courtesy of the Federal Reserve. We have nothing to fear about running big government deficits when, faced with a significant recession and double-digit unemployment, the federal government is the only spender that can take the responsibility to offset the declines in private sector output.
Apparently, we do not yet have the guts to shift from the neo-classical orthodoxy. Chicago school economics is still too much our religion. It persists until we all go on food stamps. The country that detests ideology is too ideological to manage any kind of serious change prior to crisis. As a result, a new crisis is almost certain to come, which will force the change that our elites still refuse to contemplate.
This post originally appeared on New Deal 2.0.