Yesterday I looked at a graph from J.W. Mason's The Myth of Reagan's Debt. The graph shows "the overall and primary budget balances for the federal government since 1960," Mason says.

"The balances are shown in percent of GDP," he adds.

That troubles my friend Jazzbumpa. Jazz asks Mason

How do your graphs look as straight values, not as ratios to GDP? I'm always suspicious of the denominator effect.

Following up on his own blog, Jazzbumpa says

J.W.M. is looking at surplus or deficit as a % of GDP. Conclusions based on ratios always make me want to take a different look.

And then Jazz did take a different look. He found a source for overall and primary budget balance numbers. He made a graph comparable to Mason's, but showing budget balance in billions of dollars rather than in percent of GDP.

I grabbed Jazzbumpa's source data, stuffed it into a spreadsheet, and duplicated his graph:

Graph #1: Overall (orange) and Primary (blue) Federal Budget Balance |

There may not be much distortion from a denominator effect in this specific case ...

and again:

For the period in question, this [straight values graph] does not look substantially different from JWM's graph, with data as percentage of GDP.

Okay. That's why we do graphs, you know? To see how they turn out.

I had a sudden urge then to subtract the primary balance from the overall balance, so that I might see the shape of the space between the two. The subtraction would show me the portion of the deficit caused by the payment of interest, so to speak.

It was simple enough to perform the subtraction, seeing as how Jazz had already done all the legwork.

Graph #2: Take Graph #1 and Subtract the Blue Line from the Orange Line |

Allow me to remind you that Jazzbumpa created his Graph 1 as a version of JW Mason's graph that is not expressed as a ratio. Jazz omits GDP from the calculation because he is concerned that the changes in GDP will give rise to changes in the ratio, and that we (the viewers of graphs) will mistakenly attribute those changes to the numerator -- to the Federal budget deficits -- when they might in fact arise from the changes in GDP.

An excellent precaution.

However, looking at Graph #2 here, at Graph #1, and then Graph #2 again, I want to say that in Graph #1, Jazz did not manage to eliminate the denominator effect. Oh, he eliminated the denominator, for sure. But the jogs and jags on his graph are intimately related to GDP, the denominator that he eliminated.

Jazz eliminated GDP from his calculation.

*But that did not eliminate the effects of GDP from the Federal deficit numbers.*The Federal government always runs big deficits at times of recession.

Graph #3, from November 2010 |

Removing GDP from the debt-to-GDP calculation does not eliminate the tendency for Federal deficits to rise during times of recession. Removing GDP from the calculation does not remove the effects of changes in GDP from the Federal budget balance.

Subtracting the primary deficit from the total deficit eliminated most of those effects. That's what the smoothness of Graph #2 tells me.

Oh, and by the way: Graph #2 shows a big increase in deficits in the 1980s, an increase that began, I'm tempted to say, in the 1950s.

## 2 comments:

not sure if that last line should read "a big increase in deficits" or something else: "a big increase in financial costs" maybe

My post had a very narrow focus - to justify my continued contempt for Reagan. I wanted to indicate that his taxing and spending policies blew up the primary budget. Mission accomplished.

Your graph 2 really brings home JWM's main point - that the interest payments were huge during the 80's and dominated the total deficit.

I didn't intend to eliminate the influence of GDP on the deficit. That wasn't on my radar screen. I was just making sure the math wasn't distorted. Certainly GDP growth and interest rate changes are related; but it's not clear to me that there is a stable leader-follower relationship.

Re: "Graph #2 shows a big increase in deficits in the 1980s, an increase that began, I'm tempted to say, in the 1950s."

Yeah, there was an interest payment influence even back then. But I don't think anyone would have extrapolated the 50's numbers into the 80's reality. Nor do I think that the seeds of the 80's were planted in the 50's. Too much intervened. And, clearly, your graph 2 shows an inflection point right around the inflation peak of 1978. As you show in your graph 2 of the "Inflation Was Still High" post, interest rates remained well above inflation for the next 12 years.

IIRC, Krugman has made the case that 70's inflation was largely the result of energy price shocks.

http://www.macrotrends.net/1369/crude-oil-price-history-chart

Now I wonder - did Volker really kill the inflation dragon, or did it die a natural death when it ran out of fuel?

Cheers!

JzB

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