Saturday, February 16, 2013

Interpreting the federal debt - GDP ratio.

"So, as you can see, during the 70s we had deficit spending that ran up the national debt, until Ronald Reagan was elected in 1980 and restored fiscal soundness. Oh, wait; it’s actually the opposite. 
"The truth is that whatever you might say about economic policy in the 1970s, it had nothing to do with Keynesian fiscal policy — and did not involve increasing debt. People on the right tend to use “Keynesian” to mean “liberal stuff I don’t like”, but aside from that definition, the 70s tell us nothing about the issues we’re discussing right now. You can argue that monetary policy was too loose, that the Fed was too expansionary in 1972 (when Arthur Burns was trying to reelect Richard Nixon) and that it failed to tighten in the face of oil-shock-driven inflation. But again, the idea that this experience has any relevance to expansionary fiscal policy in the face of a liquidity trap is totally bogus." 
Paul Krugman in the New York Times.
So lets look at this graph again. Federal debt decreased in relation to the GDP and was quite low until the Reagan administration. It rose rapidly under Reagan and Bush I. It came down under Clinton and began to rise again under Bush II. Then came the housing bubble crash which catalyzed the subsequent financial crisis and the Great Recession. There followed a reduction of the GDP due to the recession and a lot of deficit spending to restart the economy. Most economists seem to agree that the stimulus package was a good idea and has helped the United States restore growth in GDP.

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