The Deficit Did Not Cause The Recession, The Recession Caused The Deficit [View all]

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http://www.businessinsider.com/deficit-did-not-cause-the-recession-2012-11

Both Wall Street and Washington have lost sight of the major cause of the deep recession and exceedingly slow economic recovery. To hear all the talk, the major concern is about the impending fiscal cliff and the federal budget deficit. Fix the fiscal cliff and make major reductions in the deficit, they say, and all will be ok. We think they've got it wrong.

As we've been writing about for a number of years, the major problem affecting the economy is the credit crisis of 2008, brought on by the preceding housing boom, explosion of household credit and the associated sleazy practices by the mortgage banking industry. Also culpable were the various enablers such as Alan Greenspan, overall Fed policy and the major credit rating agencies. When the boom collapsed, households were left with a severely depleted asset (their homes), record debt and low savings. Since that time consumers have been faced with the problem of paring down debt and increasing savings at a time of extremely limited increases in wages, a process that is still ongoing today. The result is the weak recovery that typically follows major credit crises.

The federal government deficit, far from being the cause of the lackluster economy, was actually a result of it. In 2007, the deficit was a manageable 1.7% of GDP. The non-partisan Congressional Budget Office (CBO) forecast deficits of between 0.7% and 1.5% of GDP for the years 2008 through 2011 and surpluses for the seven following years through 2018. What threw this forecast off track was the deep recession, resulting in collapsing tax revenues, increased unemployment insurance and various stimulative spending programs that wouldn't have happened if not for the preceding housing and credit boom.

The concern over the deficit has now gotten mixed in with the fiscal cliff as the major problem holding back the economy. The fiscal cliff is an artificial problem manufactured in Washington during the debt limit negotiations in the summer of 2011 that caused the loss of the U.S. triple-A credit rating. The stock market is now responding to every statement by our political leaders on the status of the negotiations as both political parties jockey for position. It is perfectly natural, at the start, that both sides would attempt to sound conciliatory without being specific so that they could place blame on the other party should things go wrong.


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