The End of Affluence

The last time Americans were strongly in favor of balancing the federal budget was during the Great Depression. Then, as now, the public generally thought that budget deficits were the cause rather than the result of their economic problems, and few politicians, including Franklin D. Roosevelt, disagreed or dared to contradict them. In his 1932 presidential campaign, Roosevelt criticized Herbert Hoover for not reducing federal deficits, and when the economy began to recover later in his first term, partly because of his own spending programs, he decided to deal firmly with the government’s growing deficit. By 1936, the deficit had risen to more than 5 percent of the gross national product, compared to less than 3 percent today. But FDR’s sharp cuts in government spending in 1937 did not have the effects he had hoped for; instead they contributed to a sudden, fierce recession later that year which reduced tax revenues and thwarted any attempts to balance the budget.

What FDR would learn during the next few years was that the opposite policy probably would have been preferable. Despite the Depression, the American economy retained so much capacity for growth that the stimulus of greater deficits, along with cooperative Federal Reserve policies to lower interest rates, would have expanded incomes and production rapidly—as deficit spending did during the war years—and probably raised tax revenues sufficiently to eventually eliminate the federal deficit. This of course is what happened after the war.

Today, we do not have this option. Since the early 1980s, the United States has run large budget deficits year after year, yet the economy has grown unusually slowly during this period. In view of the economy’s performance, there is certainly no good reason to believe that still larger deficits would have raised the rate of growth during these years or that the financial markets would have permitted such deficits, even if the government had pursued such a policy. With even larger deficits, fears of inflation would probably have driven interest rates so high that the effect of any added stimulus would have been offset by the higher cost of borrowing. As it is, most forecasters, including those at the Federal Reserve, believe that the economy will grow by only about 2.5 percent a year. At that rate of growth we now have little choice except to reduce projected government spending; otherwise federal deficits will rise further, continuing to strain the world’s financial markets and diverting more scarce funds away from investment.

To most Americans, therefore, it appears that we have no alternative than to do what FDR did in 1937, despite the risk of recession that rapid reductions in the deficit might entail. While the American economy is of course not as fragile as it was during the Great Depression, partly because of such “automatic stabilizers” as Social Security and unemployment insurance, both the Republican and the Clinton administration’s proposals to balance the budget are likely to slow the economy …

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