Tag Archives: debt

Why Deficit Spending During Recessions is Good

Why do most economists believe that governments should run deficits during recession? Isn’t borrowing money bad?

There’s some truth to the idea that borrowing money is often a bad idea for individuals and families. But we all know there are exceptions. For one, when there’s an emergency, you might not have any choice. And, contrary to popular analogies, government finances are very different from those of families.

Government revenues (aka “taxes”) are closely related to families’ and companies’ incomes, but that’s about where the similarity ends. When people lose their jobs in a recession, governments collect less in taxes. When corporate profits decrease, governments collect less in taxes. And we’re talking about governments at all levels here, from local to state to federal.

So what do governments do when they’re receiving less revenue? Local and state governments essentially have to run balanced budgets by law, so they cut spending. And this hurts the economy even more, causing more unemployment, and leading to even less tax revenue. What’s worse, the effects of decreased government spending get multiplied as the reduced money flows around the macroeconomy.

To be fair, there are natural forces that do eventually help economies recover. Real wages may fall to the point where companies finally start hiring again, for example. Eventually economies do tend to right themselves. The key word here is “eventually”. Unfortunately, it can take a country’s economy a decade or more to “fix itself”. Look at the Great Depression, or Japan’s Lost Decade.

To help the economy recover faster, we need to make up for the decreased investment spending by firms and decreased consumer spending. For better or for worse, the only entity in a position to do that is the federal government, since unlike state and local governments it is able to borrow money fairly easily.

As a result, the best minds in economics say that running a federal deficit during recessions is a good idea. Doing so will help to pull the economy out of the recession faster, and will reduce its severity.

There are some caveats, though.

Most importantly, governments should not be running deficits during expansions. If anything, the federal government should be running surpluses during expansions in order to pay down the public debt. This helps to clean up the government balance sheets in preparation for the next recession. Unfortunately, U.S. governments have shown an inability to do this. With the exception of the late 1990s, when politicians have seen surpluses, they’ve seen the opportunity to buy votes with tax cuts. This sounds good to many voters, but it’s bad news for the economy.

Second, borrowing money even for good reasons has implications. For one, you have to pay interest on it, and that costs money down the road. This is another good reason to pay down the debt during expansions.

Third, someone has to be willing to lend you the money. So far, the interest rates that the U.S. has to pay for the money it is borrowing are still low, partly because most other countries are even worse shape than the U.S. But as public debt as a percentage of GDP continues to increase, the interest rates the U.S. government will have to pay are bound to eventually start to increase, and that can cause serious problems. See Greece, Spain, and Italy for more of that. At the end of the day, no government can continue to borrow more and more money at an increasing rate indefinitely.

So the bottom line is that deficit spending during recessions is a necessary evil. Economists don’t like governments having to borrow money, but in downturns, it’s for a good cause. But there’s always a trade-off, and there are limits to how much any government can and should borrow. Eventually we’re going to hit those, and at that point we’ll have run out of options.

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Consumer Debt Continues to Decline

Consumer debt continues to decrease. Households seem to be getting their finances in order, which eventually should be good news for the economy. With less debt hanging over their heads, consumers will be more willing to open their wallets, which can help stimulate economic growth and create more jobs.

The ratio now is below 1.1 after having been over 1.3 in early 2008. However, by historic standards, the ratio is still high. Up until 2001, it was below 1.0, and before 1986 it was less than 0.8.

Credit Cards and Irrationality – Protecting Us from Our Brains

Human beings are rational.

It’s a basic assumption of economics. Humans are rational beings. Homo economici. We don’t intentionally try to make ourselves worse off.

In his book How We Decide, Jonah Lehrer cites a wide range of psychological, behavioral, and economic research to argue that emotions guide many of our economic decisions. He makes the case that emotions are not just irrational feelings of love and hate, but instead are the result of how the human brain is wired.

And these emotions can cause us to do things that are bad for us.

Take credit cards. Buying things with cash activates a part of the brain called the insula. We actually feel a sort of subconscious pain – emotional discomfort – when we spend cash, since we’re physically giving up something.

When we pay by credit cards rather, however, our brains don’t feel the same sense of loss. Brain scans show that paying with credit cards reduces activity in the insula, causing us to feel less discomfort about the purchase. We literally feel it costs less with credit than with cash.

Basic economic theory says there shouldn’t be a difference between paying by cash or by credit card. Both involve the same loss, so we should view both the same. If anything we should feel worse about paying by credit card, since that could result in having to pay interest or late fees, .

But that’s not how the brain sees it. Which is why so many otherwise rational people get in over their heads with credit cards.

I remember when I was in college and got my first credit cards. Even as an arguably intelligent and sensible person, I still fell into the trap and over-extended myself. Fortunately for me, I got a steady job and eventually was able to pay off my debt. But it took many years to do so. If anything had gone wrong before I did – if I’d gotten sick or had lost my job – I could easily have fallen into a vicious cycle of debt dependent. And if that had happened, I doubt that I would now be here writing about the dangers of credit card debt.

Credit card companies know about the brain’s weaknesses and use every trick they can – low introductory rates, fine print, hidden fees – to take advantage of them. And they’re really good at it. So good in fact that millions of Americans get into credit card trouble every year.

It’s easy to say that this is their problem. They got themselves into trouble. Let them get themselves out of it. And there’s some truth to that. Society can’t take responsibility for every bad decision. Choices have consequences. People need to learn that and take responsibility for their own actions.

But a good case can be made for trying to prevent the worst abuses, particularly since neuroscience research – actual brain scans – tells us that it is due to the very way the human brain works.

From a self-interest perspective, having so many people getting into credit crises also isn’t good for society as a whole. People who get in over their heads aren’t able to pay their bills, are likely to have psychological problems, will have more trouble holding on to their jobs, and will have difficulty caring for their children. This makes it more likely that their kids will grow up to have problems in life as well, thus perpetuating the problem.

Fortunately, the U.S. government has been taking steps to curb the worst credit card abuses. The recently-establish Consumer Finance Protection Bureau has taken an aggressive stand against credit card companies that use unethical means to prey on consumers.

I’ve always been opposed to unnecessary government regulation and involvement in the economy. Government regulation imposes a burden on businesses and on society, unless there’s a good and overarching need for it.

In this case there is. There are situations where people do need to be protected from themselves, and this is one of them.

Sometimes people need to be protected from the flaws in our own brains.

It’s only rational.