Remembering the Lessons of Economics 101: Why Increasing the Federal Deficit Does Not Mean that Our Kids Must Sacrifice to Pay the Bill

Everyone who took Economics 101 (at least when I took it 40 years ago) remembers their professor asking what at first might have appeared to be a trick question: "When the economy goes into recession, the natural tendency of consumers is to spend less and save their money. Is that a good thing for the economy?"

Sounds logical enough. When your income drops or you face the threat of losing our job, you tighten your belt. How could that not be the right thing to do?

Of course the answer is that such belt tightening is a disaster for the economy. It contributes to the downward spiral of economic activity: less consumer demand, less money invested to create products to sell to consumers, less people hired to make or sell those products, less consumer demand and so on.

Now you can't require that individual consumers spend more when they have less money -- so the answer to ending the recession or restoring growth is for the Federal Government (all of us acting together) to invest more money in the economy and put people back to work. And that's true even if you have to massively increase the Federal deficit.

That critical understanding was one of the chief lessons America learned from the New Deal. But, at least until its massive and irrefutable failure this year, the conservative conventional wisdom that dominated political and economic debate since the mid-1970s has convinced many Americans that deficits are always evil.

The conservatives' success in vilifying deficits as a tool of fiscal policy is all the more remarkable because the Republican administrations of Reagan and Bush II created many times more deficits than all of the other American presidents in our history combined. But it has served their interests, none the less, to pray upon normal people's natural aversion to debt as a weapon in their war to reduce the size and spending of the public sector.

Perhaps their most successful argument has been their claim that when we run Federal Budget deficits that our children will be forced to "sacrifice" in order to pay off the massive debts that have resulted from our "out of control" Government spending.

It may sound obvious that when the Federal Government spends more than it takes in -- and borrows money to make up the difference -- that our kids must ultimately sacrifice to pay the bill. But when you look more closely, this notion is also wrong.

Someone must, of course, always pay the bill for the debt we have incurred. The fallacy comes from the view that future generations must "sacrifice" to do so. In fact, they are often much better off than they would be if the Government "lived within its means' and didn't create the deficit in the first place.

To understand why, you have to think about what we really mean by "wealth" or "well being". Wealth is created when people produce products or services out of the raw materials we find in our environment using the tools we have created for that purpose. Wealth is created by human labor -- by economic work.

The measure of whether or not future generations will be wealthier or must "sacrifice" because of our actions today is whether those actions generate more labor and allow that labor to be more productive in the future. In other words, the amount of wealth we produce is a function of the number of hours we work as a society and the degree to which we increase the productivity of labor so we can produce more wealth per hour.

The more fully we employ our work force -- the more we invest in education, and technological innovation -- the more wealth we create.

When the Federal Government borrows money to put more people to work -- to build bridges, or mass transit lines, or repair schools, or provide health care or to allow people to buy food -- it directly increases our store of wealth and that of our children. That is particularly true if people are working to create products that will be used over many years or increase our productivity -- like a new power grid, new schools, or public transportation. What's more if that deficit is used to jump start the economy to begin the upward economic spiral of more consumer demand, more investment, more employment, higher incomes, more demand and so on, it can exponentially increase the wealth of future generations.

In times of economic recession or slow growth, deficits do not force future generations to sacrifice to pay off our debt. In fact the use of deficits bequeaths our kids wealthier more prosperous lives -- even after they pay off the debt created by the deficit.

Our kids would be in far worse shape if we failed to generate the deficit and allowed the downward spiral of economic activity to continue.

By fits and starts Franklin Roosevelt learned these lessons during the Great Depression. His willingness to generate deficits early in his first administration gradually put the brakes on the economy's downward slide, until advisors convinced him that he must cut the deficit. That caused the economy to slide back in to deep recession until it was rescued by the massive deficits generated by World War II. After Pearl Harbor no one questioned the absolute necessity of fully employing everyone in America -- and all of our plant and equipment -- to produce what was necessary to win the War -- even if we had to generate deficits to do it.

Clearly in some circumstances excessive Federal debt can crowd out other debt, drive up interest rates and choke off economic growth. A recession is not one of those circumstances.

Next month President Elect Obama has proposed that Congress consider a large jobs and economic recovery program that is intended to create or preserve 3 million jobs -- and jump start our economy.

Some Republicans will argue by analogy that when times are tough you don't increase your spending, you tighten your belt and live within your means. That may be a good idea for an individual. It's a terrible idea for a country.

When times are tough for a community or country, we need to do whatever is necessary to put everyone to work producing more wealth. That's what will determine the economic well being of future generations, not the size of our deficit.

Robert Creamer is a long time political organizer and strategist, and author of the recent book "Stand Up Straight: How Progressives Can Win," available on Amazon.com.

Comments

[mcostello]

The core of Mr. Creamer's beliefs are not stated, but perhaps flawed, and they are:
The "growth-dependent" economy, and
infinite resources.

I have always been sceptical of the model of a growth dependent economy (i.e. the economy continues to do well as long as it continues to grow), because eventually the economy runs out of resources.
We are nearly there, and with 7.8 billion mouths to feed.
The trick now is to thrive in the face of diminishing resources in an over-populated (with humans) world.

And no one is even talking about world population.

[redbird45]

I have been a real estate investor for 15 years. one of the first things that I learned is that there are two kinds of debt. Credit card debt is bad. Mortgages are good debt because you are investing in something that will support you. (and the properties that I own are getting me through this difficult time because I keep them rented) the debt that we have accrued with the "war against" I'm not sure what because it kept changing, this debt was bad. we will not get a return from it. we will be paying this debt for a long time.
If the President elect creates debt to fund our infrastructure improvements (bridges, water mains, levies, roads etc) and to encourage business start ups in green industries. this will be good debt. ultimately jobs, travel, purchases will all create tax revenue which will allow the government to keep running.

I won't go into the Guns or butter argument because we will have neither if things don't change soon

[kcleader]

All I can think of is the 70's and the rampant inflation. An old German farmer came into my office and said the current state of the economy (in the 70's) reminded him of Germany after WWI when it took a wheelbarrow full of money to buy a loaf of bread. I say hang onto your pants because the US treasury printing presses are going to roll and roll. The inflation cycle will be our next wild ride.

[gerald4]

The USA is being economically conquered because foreign governments and foreign individuals use these dollars (and other US securities that they earned in exchange for their products that they exported to the USA) to purchase real estate, industries, breweries, hotels, factories, casinos, financial institutions and everything else of value that is located in the USA.
The US government does not borrow money, they crank up the presses and print more dollars, T-Bills, Government Bonds, Securities, etc. and sell these instruments to everybody for cash. This cash pays for our negative balance of trade, pork barrel projects, government payrolls, bailouts, entitlements, operations, social schemes, wars, new infrastructure, wealth re-distribution, and etc.
There is probably a limit to the amount of paper dollars, securities, bonds, etc. that the foreign country manufacturing people and the foreign country raw material supplying people will continue to accept in payment. This limit will become apparent as soon as foreigners own everything of value in the USA and nothing is left for foreign dollar holders to buy with their dollars. This is selling of our children's legacy to foreign owners and the US government calls it "Investing in America".

[Ilyich]

Keynesian economics, as you argue for is a good way of stimulating an economy, but not ours. We have too much federal debt. Interest payments for the fiscal year 2006 was $405.9 Billion. This consumes funds that could be used to directly stimulate the economy through spending on high employment projects. Economic history in the last century is littered with countries that have collapsed from high debt including Mexico, Argentina 1995, Thailand, Hong Kong, Malaysia, South Korea Laos and the Philippines during the 1997 Asian Financial Crisis. Debt payments after WWI ruined Germany. With debt there is the risk of bankruptcy. To sell more T-bills to replace matured ones and also to cover increasing debt, the dollar must fall or the interest rise. Debt has a price, unless the U.S. defaults or we have hyper inflation and pay it back with cheap dollars. Our ability to follow Keynesian economics has been hampered by the doubling of the federal debt to over $11 trillion under Bush. Moreover, with the global crash, who has surplus funds to buy T-bills? For more on the debt crisis go to http://skeptically.org/crash/id16.html.

[cayuse]

There is a big difference on what the government spends money on

Remember GUNS vs BUTTER

Remember Money Supply manipulation vs Kaynesian stimulation

Repubicans, Milten Freeman and Greenspan obviously know MS and now we too. Just like the did in the 20's, 80's, 90's, 2001's, and 2008's

There is a big difference of spending that creates Jobs when we are in a depression or recession and the Republican spending for WAR, Tax free Profit and Privatization.

The hope is there is money left after January 20th? It was our only chance, but we must pay it all back or pass it all on. I say tax the RICH, like 90% again

[gde]

You caught the major omission in the article. Not all spending is investment. And, not all investment is good for the economy. As Bill Greider pointed out ("Who Will Tell the People ..."), the Reagan era massive cuts in corporate taxes were used to close plants in the US and build plants overseas. Thus, the money was used for disinvestment as far as the US was concerned. There is only slightly offset by the effect on the total world economy being positive, since the effect on the US economy is so much more negative. The effect on the world economy of war is always strongly negative, although sometimes a nation can gain if it succeeds in stealing sufficient assets from someone else as a result of that war.

[Binea]

I have the answer.
In The Old testament there is something called the Jubile. It was supposed to take place every 50 years. All Debts were forgiven .There is much more to the biblical jubile,literally and spiritually,but the concept makes sense.
Since the whole world seems to be in this recession headed for a world wide depression,why can't our leaders agree to a worldwide Jubile. All countries forgive each other their debts,all countries forgive their citizens debts,and all those within the country forgive each others debts and we can just START OVER from 0.
That's the answer. . .
But of course the world and all within it will never cooperate.There are alot of good answers.The problem is people.and their greed and lust for power.

[laocoon]

One persons debt is anothers asset. Many of the assets we now hold will be destroyed.
The losers would be disproportionately the wealthy but others could be effected. Some types of businesses would be put out of business. There are studies about how exactly the jubilee system would have worked in ancient Israel.

[JimGroom]

As Dick Cheney said 'deficits don't matter.' I guess we will see soon enough.

[VivaZapata]

So far Cheney's batting a thousand; i guess one more whiff at the air won't matter.

[Articulator]

Deficit spending could well be the way to go if you are starting at zero and you have some room to work with, but if you are already up to your eyeballs in debt when you start deficit spending that makes me worry. Unfortunately there are few choices. A "service economy" with big trade deficits may not have a lot of juice to be squeezed out of it in times of need. Sending all the manufacturing jobs overseas may have seemed like a good idea at the time... I do not fear govt spending though, all the tax money collected in a year (and then some) gets sent right back into the economy each year (there are no big mattresses in the treasury with all the money stuffed in it) and as this article points out, having things like good schools and infrastructure does make the next generation more productive.

[BlueTide]

As a doctor of economics, I can say you have a good grasp of economic concepts. There is no question that our well being is determined by the goods and services we produce. Money is important because it facilitates trade and is a way to store value for the future. However, money really isn't wealth at all in a real sense. What makes us better off is to have food, shelter, clothing, medical care, entertainment etc....

Another valid point is that total net debt in the universe is always zero. For every debtor there is a creditor. Debtors benefit from going into debt because when their wealth is down, they can smooth out their consumption path. Creditors also can smooth out their consumption profiles by lending when their wealth is up. There is nothing wrong with debt. Without debt, most people would not be able to purchase a home or even a car. Today, the federal government needs debt to rebuild our infrastructure and to prevent an economic depression.

[beaupritchard]

Debt is good until someone wants their money and you don't have it. Then to collect on debt they want what that money created ... in your words wealth. Since wealth is goods and services roads bridges land people ... that's what they want.

There's a reason why nations have standing armies. Standing armies are for repelling nations who want to collect debt in the form of land food water slaves ... or for collecting debt in the form of land food water slaves from nations that owe.

Standing armies are for when nations stop believing in economic theory and reassert certain darwinian realities.

The person who lends you money is not just doing you a favor. He wants something you have ... whether its that car or that boat you put up for collateral ... part of him wants to see you fail. Otherwise he would not need collateral to make the loan.

So it is with nations. China is not lending us money because it loves us. China wants something from us ... whether the implied collateral is Taiwan or Tibet ... it wants something if nothing more than our non intervention in what they believe to be their affairs. And so it is with the world.

To economist its all a delicate balance of paper and numbers and charts. To the rest of us it's lost blood and sweat and the tears of loved ones. Economist need to lose a few sons and daughters in a few

[laocoon]

the problem gets to be when debt and credit are so allocated that exceeding disproportionate shares of real product go to a very few. Debt credit relationship are essentially ones of leverage about the ongoing product and how it distributes.

[peterg76]

The important lesson is not from Economics 101, but from Personal Finance for Dummies. It is necessary to distinguish borrowing for consumption - money which is gone forever and will have to be replaced by new earnings - and borrowing for investment - money which will continue to be an asset of some form with an overall expectation of increasing in value though with some element of risk.

Building needed infrastructure (not bridges to nowhere) is investment and improves quality of life, whether it is reflected that way in the money economy or not. Paying off Wall St. gambling debts is consuption. Practical automobiles are investments; extravagant automobiles are lifestyle choices and are consumption.

[Bonobo]

Several responders have made the point that deficit spending can be good or bad, depending on whether it leaves something of enduring benefit in the community doing the spending. Much of the outrage over "pork barrel" spending concerns examples of bad spending, i.e., bridges to nowhere. The challenge is to distinguish broad benefit projects from lobbyist giveaways. An early test for Obama, which he may have already failed (with the nominations of Vilsack and Chu), is the biofuel fantasy.

Corn ethanol is little better than break even on energy gain, and has all sorts of unpleasant effects on food production and environmental damage. Cellulosic ethanol is still in the research phase, has many of the same side effects, and is fundamentally limited by photosynthetic efficiency (

[Bonobo]

Oops. Don't know what happened there. Here's the second part in full:

Corn ethanol is little better than break even on energy gain, and has all sorts of unpleasant effects on food production and environmental damage. Cellulosic ethanol is still in the research phase, has many of the same side effects, and is fundamentally limited by photosynthetic efficiency (

[WgS]

"Stable Economy"? it doesn't get any more stable than this:

Whereas:

1) Economic growth, as defined in standard economics textbooks, is an increase in the production and consumption of goods and services, and;

2) Economic growth occurs when there is an increase in the multiplied product of population and per capita consumption, and;

3) The American economy grows as an integrated whole consisting of agricultural, extractive, manufacturing, and services sectors that require physical inputs and produce wastes, and;

4) Economic growth is often and generally indicated by increasing real gross domestic product (GDP) or real gross national product (GNP), and;

5) Economic growth has been a primary, perennial goal of American society and government, and;

6) Based upon established principles of physics and ecology, there is a limit to economic growth, and;

7) There is increasing evidence that American economic growth is having negative effects on the long-term ecological and economic welfare of the United States and the world...

Continued...

[websmith]

That kind of thinking will insure a life of serfdom for our children. They will struggle ever day of their lives just to survive. When the elite who own them get tired of feeding so many, they will starve everyone just to see who survives. The problem was that there were too many people, they will say.

They have done this in Ireland, India, Australia and Latin America. They tried to do it here, but we were too smart for them once upon a time.

Economics 101 is, if you spend more than you have or borrow more than you can expect to pay back, you will have economic problems. The current problem is that people don't have money to spend. Too much of it is going towards the payment of interest.

http://ewebsmith.com/Finance/hiddendemon.html

[WgS]

One of the first things we need to do to change our thinking is to stop using words like 'elite.' There is nothing inherently superior about any person nor is any person disposable. So a group of people designed a game, made the rules, taught their offspring how to maintain the advantage of the game. The game still only has value providing enough people agree to play it.

I would guarantee you that the next time they needed to consolidate their position, they would once more change the rules using more convoluted reasoning. *presto-chango*

[laocoon]

They also then used their advantage to buy politicians and to manipulate demand.....

[WgS]

Most respectfully, Mr. Creamer, "blah blah blah"...

The economic principle that sounds in my mind is one of finite resources - wants, needs and choices.

We have been collectively making choices in the pursuit of growing wealth that has led to massive over consumption and the depletion of scarce resources. Even if you do not factor the concept of climate change into the equation, continuous growth models are unsustainable. Wealth does not create more trees, regenerate more species nor (apparently) prevent pollution and environmental degradation. If the latter were true, then more of the wealthy would be promoting the investment of such wealth into these efforts. Overwhelmingly, the actual results have been the opposite.

Certainly the wasting of such resources is robbing from future generations of them and further investing them into the cycle of growth without their knowledge or consent.

Personally, I don't know why the idea of slowing down unsustainable growth is such a horrible thing, but then I am not wealthy nor aspiring to be.

[WgS]

I should amend the last statement: I am not wealthy by American standards nor aspiring to be.

[research]

Normally true.

But we have unique history need and opportunity:

Solar and wind and efficiency.

Energy Independence.

No more wars for Oil or energy.

http://www.huffingtonpost.com/users/profile/research

[BelGazou]

Deregulation of the financial sector has lead to massive abuses by the mortgage and finance industry and their willing marks. Growth is good depending on what that growth in based on and whether or not rules remain in place to stop speculation and fraud.

I neither own a home nor a car but I will be happy to see the end of the internal combustion engine, the McMansion and over-priced housing.

[ProgressiveVoice]

When I took Econ 101 - during Reagan's 2nd term - I was told the same thing: deficit spending is appropriate governmental behavior during a recession. But there is a corollary you left out: there should be government surpluses during the good times. It's the equivalent of you and I putting 5% or 10% of our paycheck into a savings account - the good economic times - in order to survive a period of unemployment - the "recession". The government has the added advantage of not having to "save" surpluses. They can be used to stimulate the economy by paying off debt, as a rebate to tax payers or new or additional investment for the common good.

Since the surplus years of Clinton, the GOP have shown their real ideology. The real GOP agenda/ideology has been to steal taxpayers money through shifts in tax policy - unfunded mandates to the states, shifting tax burden from wealth to work, etc. - and now, the final looting of America, the bailouts. Add up all the money the government has given out the last two months - especially the monies announced that apparently did NOT need Congressional approval, like the AIG deal. Did anyone notice the appropriation of $25B to US automakers, the news of which appeared the same weekend everyone in the country was talking about Bush's request for $700B? ($648B - $608B to DOD, $25B to automakers, $15B for "earmarks" - also the only spending that was a direct benefit to

[strick9]

Debt is no different than slavery, whether individual or of the state. The only difference is that there is an agreement between the slave and the master for the terms of the agreement. Governments make deals behind closed doors that benefit unknown elements. In my lifetime I have noticed a cycle.

Democrats increase debt and taxes by increasing social programs and rebuilding infrastructure.

Republicans reduce taxes by cutting social programs and cutting infrastructure projects. Our roads and bridges crumble and sewers and water mains collapse, but we pay less taxes. How much less taxes did we pay for the people killed when the latest bridge collapsed? What of the unwed mothers created by their lack of available birth control options, or the unemployed construction worker or father forced to compete with his child for some minimum wage job while food and housing cost rise daily. How secure do you feel when those forced into poverty steal your stuff to survive?

Democrats create social programs to help people survive dealing with Republicans on a daily basis.

Republicans devise ways to control the people and bankrupt the system. One example is Farm subsidies designed to help family farms survive have created corporate farms that have used the system to take over small farms and take all the free money.