Wednesday, July 29, 2015

The red line

"Why did rich-world deficits start exploding around 1980?" - Noah Smith

Start with the last graph from last time:

Graph #1: Federal Deficits (blue) with Inflation Removed (red) Base Year=1958
Annual change in Federal debt as a measure of deficits, divided by the GDP deflator to remove inflation, then multiplied by 17 (instead of 100) to show dollars from 1958 (instead of from 2009). That's the red line. The blue line is annual change in Federal debt, not adjusted for anything.

Get rid of the blue line:

Graph #2: Inflation-Adjusted Federal Deficits (Base Year 1958)
Okay. The red line here looks similar to the blue line on Graph #1. The three high peaks are lower, of course. Well, all the numbers are lower. All the numbers after 1958 anyway. The three high peaks on the red line, the peaks come at about 75 on the vertical axis, and about 90, and a little under 100.

Those peaks have the same values on Graph #1 of course, but they're easier to see on Graph #2. It's also easier to see what Noah called an "explosion" of deficits on this red line -- if you're looking for it.

Me, I'm not looking for it. I cannot imagine Maynard Keynes or Adam Smith seriously discussing an "explosion" of deficits. I learned what economics is, from them. I learned what economics is not, from Milton Friedman.

It is pretty obvious that the big jump on the graph occurs at the 1982 recession. And it looks to me like the second biggest jump occurs at the 1974-75 recession. Third, probably the 1991 recession. So I have to think that the big jumps in the deficit are recession-related, not 1980s-related.

Does it matter? Well, yeah. If the big jumps are recession-related it means they are Keynesian policy. If they are 1980s-related it means they are Supply-Side policy.

I think we can see supply-side policy on the graph, in the tapering off of deficit peaks. The strong upward trend established by the deficit increases of the 1970 recession, the 1974-75 recession, and the 1982 recession, the uptrend has broken by the time of the 1991 recession. That last peak is lower than the trend suggests it should be.

And after the 1991 recession, the deficits actually fall. Clearly, this is supply-side policy at work. Supply-side, or Reaganomics, or whatever you want to call it. Furthermore, the effects of this policy are delayed -- as we should expect. Policy is not instantaneous: Policy establishes trends.

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