Krugman: Deficits don't matter saved the world

o Deficits saved the world (Krugman)

What we’ve had is a sharp increase in the desired private surplus at any given level of GDP, due to a combination of higher personal saving and reduced investment demand. This is shown as an upward shift in the private-surplus curve.

In the 1930s the public sector was very small. As a result, GDP basically had to shrink enough to keep the private-sector surplus equal to zero; hence the fall in GDP labeled “Great Depression”.

This time around, the fall in GDP didn’t have to be as large, because falling GDP led to rising deficits, which absorbed some of the rise in the private surplus. Hence the smaller fall in GDP labeled “Great Recession.”

What Hatzius is saying is that the initial shock — the surge in desired private surplus — was if anything larger this time than it was in the 1930s. This says that absent the absorbing role of budget deficits, we would have had a full Great Depression experience. What we’re actually having is awful, but not that awful — and it’s all because of the rise in deficits. Deficits, in other words, saved the world.

o When all you have is a hammer (Denninger)

Folks, we went from a personal deficit of $200 against roughly $8,600 in per-capita income (a 2.3% deficit) to over $4,000 against roughly $25,000 in per-capita income, or a 16% deficit.

We managed to do this through debt. That is, we promised to pay in the future, $4,000 more than we made in 2005 on average, and that number went from a tiny percentage of our income (2.3%) in 1981 to a very significant percentage (16%) in 2005.

Folks, it should be obvious that this deficit cannot continue to grow forever. Eventually you must spend less than you make and pay down that debt, or you will get into a situation where you are unable to make the payments and default.

We are in this mess economically because we built capacity we do not need, and the World Bank wants us to take on yet more un-serviceable debt in order to "bring up capacity utilization"?

Are they crazy? No. Just blind.

The ugly facts are that there can be no durable recovery in the economy until the excess capacity is removed, since there are no huge productivity boosters on the horizon, the only other way you can grow demand (that is, you must boost not only GDP-per-capita but more importantly per-capita income so that true demand is generated) is to reduce the debt load in the system.

Note that per-capita GDP compared to per-capita income has gone the wrong way since 1981. That is, the "spread" (as a percentage) between per-capita GDP and per-capita income has increased, which is exactly what you would expect as debt service saps the funds in the economy available to go toward per-capita income!

In numbers, in 1981 per-capita GDP was $13,600 while per-capita income was $8,476, a "spread" of 60%.

In 2005 per-capita GDP was $42,200 while per-capita income was $25,036, a "spread" of 68%.

Lower "spreads" denote a greater return of GDP into the hands of people - that is, a more efficient economy. The wider the spread the more "parasitic drains" there are on GDP - that is, the greater the amount of GDP that winds up somewhere other than in the people's hands.

The ugly truth is despite the "personal computer revolution" and "robotics", all of which are vaunted "efficiency improvements", per-capita purchasing power as compared against GDP, that is, the amount of money available for consumers to spend in the economy (and to service debt) compared to gross domestic product, better stated as economic efficiency, has decreased by about 12%.

This is exactly what one would expect since much of the debt is in fact not "personal" - it is owed by corporations and governments that have "levered up", and they must pay interest too. As a consequence larger and larger portions of GDP are diverted not to per-capita income where consumers can spend it, save it, pay debt with it or form capital with it, but rather are diverted to the non-productive use of paying interest and in doing so damages the economy.