June 13, 2012

A deficit is not a fiscal stimulus

Many commentators have claimed that there is no austerity because there is still a large budget deficit. If the government is spending more than it receives in taxes then there must be - in effect - a fiscal stimulus. Therefore it is a myth that the government is pursuing an austerity policy because the real cuts have not started yet.

This argument was shown to be a fallacy some years ago by the American Keynesian economist Gardner Ackley in a paper called You Can't Balance the Budget by Amendment written in 1982. See the excellent discussion of it by Bill Mitchell where he says:

We cannot conclude that if the budget is in surplus then the fiscal impact of government is contractionary (withdrawing net spending) and if the budget is in deficit then the fiscal impact is expansionary (adding net spending).

A government budget deficit might simply reflect the fact the economy is in recession and does not in itself mean the government is adopting a Keynesian fiscal policy. In a recession tax revenues fall and benefit spending increases naturally - the so-called automatic stabilisers - and the govenment finds itself with a deficit without having any stimulus policy- the situation in the UK currently.

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