The Shrinking Deficit and Our Shrinking Economy

The rapidly falling deficit does not "put the US in a strong fiscal position."

I thought I was done writing for today, but I just stumbled across this post, and it got under my skin. It’s probably behind a paywall for many of you, so I’ll just quickly summarize.

The US Treasury Department has reported that “for the first ten months of the fiscal year, which ends Sept. 30, the deficit was $726 billion, down sharply from $2.5 trillion in the same period last year. That’s a record $1.8 trillion narrowing.”

In the month of July, receipts rose 3% while outlays fell 15%. According to Tom Simons, an economist at Jefferies and Co., this is great news because it puts “the U.S. in a strong fiscal position.” From an MMT perspective, that’s a silly thing to say. As I explain at length in my book, the number that falls out of the budget box at the end of each fiscal year doesn’t really tell you anything about the “strength” of the U.S. government’s fiscal position.

In fact, as I recently wrote, Democrats are bragging about a historic collapse in the government deficit even though it is pushing the US private sector into a weaker financial position.

Anyway, fiscal policy has become a major drag on economic growth. That’s been confirmed by Treasury Secretary Janet Yellen, and you see it in the estimates from The Hutchins Center on Fiscal and Monetary Policy, which show that the massive collapse in the government deficit reduced GDP by 3.8% over the past year.

Some of the shrinkage in the deficit occurred because higher nominal GDP growth (driven by rising inflation) generated strong tax receipts even as real GDP contracted. But the rapid withdrawal of pandemic relief has accelerated the collapse in the deficit, which undoubtedly helped to shrink our economy in the first half of the year.