Does The U.S. Have A Public Spending Problem?


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…)

In answering this question, it’s important to make a distinction to the short and the long-term. In the short-term, the US doesn’t really have a public spending problem, as spending is what is required to compensate private sector deleveraging (spending less and saving more in order to repair balance sheets, greatly damaged as a result of the financial crisis).

Public spending is also needed to compensate for the relative powerlessness of monetary policy, the usual tool to improve demand. Interest rates are essentially zero, making monetary policy near impotent, as at the same time making borrowing for the public sector very cheap.

But, of course, monetary conditions the economy will ultimately recover, and public spending can’t increase forever, the critics are right about that. Still, there are two additional points to be made here. The first is that not everybody realizes that an economic crisis automatically increases public spending and reduces tax receipts.

The structural budget deficit is one where these effects have been eliminated, that is, it’s what the budget deficit would be if the economy would run close to what it could produce. An indication is the following figure which depicts the primary deficit (the deficit excluding interest payments) and the output gap (the gap between potential and actual production). [Read on here]