Thursday, April 26, 2012

Microeconomics is not Macroeconomics

Every now and then I hear an argument that the government needs to tighten its belt and cut spending just like a family or a business would have to in the face of increasing debt.  The government, however, is significantly different from a family or business, because it is large enough to influence the entire economy with its spending.  While it is perfectly legitimate to advocate for spending cuts, it is  unreasonable to use comparisons to individual households/businesses to support the claim.

If I lose my job and have to cut my spending, it won't have a significant effect on the economy of the nation, or even my street.  During my hypothetical unemployment, it would have no effect on my employment prospects whether or not I max out my credit cards, because I don't have the economic power to significantly change the output of the whole system.

The federal government, which has a total budget of around $3.8 trillion, has such power.  Spending/borrowing cuts by Washington would cause shifts in the economy which would hurt total output (at least in the short term, and in the long term as well according to classic economic theory).  Given the link between total output and government revenues, it's not even a lock that cutting spending would help the deficit.

Across Europe, government have been slashing their budgets in an attempt to balance the books.  But the continent now finds itself sliding back into recession, with countries that cut their government spending more slowing more than countries with governments that cut less.

The economy's complex.  Professional economists spend their careers trying to come up with scientific ways to explain this or that.  We can't afford to have voters making decisions based on false comparisons like confusing a family's budget with the government's.

1 comment:

NWest said...

At what point does the size of the budget no longer "cause shifts in the economy"?

If we just look at say, NASA. Outlays of about $10 billion dollars per year, Income of $6 billion / year.

Is the comparison of the "NASA" budget still too large to compare to a household or business? We at the "NASA Business" have to borrow $4 billion each year! How about the small business administration ($985 million outlays)?

Now we can make that argument for each program in the federal budget. In the aggregate, you end up with the same argument. It's perfectly valid that you can't continue to spend more than you take in - because at some point your debt service ends up consuming all of your income.

From an economic perspective:

Both Keynesian & Monetarist Macro interventions have failed time and again (creating bubble after bubble, and destroying the value of the dollar), yet we still go on believing that we can borrow, tax, and print our way to prosperity.

Austerity in Europe is both a combination of spending cuts and tax increases. Perhaps it's the *combination* of those, along with the refusal to reform unsustainable social "safety" nets that needs to be questioned as the failure.

Most macroeconomics is *not* scientific. Computer Models are *not* the same as scientific experimentation. There are simply too many variables in a economy to predict outcomes with any meaningful accuracy. Notice how often we hear in the news "Unemplyoment Up, Unexpectedly".

You talk about the economy being complex, yet clowns like Krugman think it's as easy a C + I + G + NX...