For a while, you couldn’t read an economics’ blog without running into a figure like the one below on the leveraging and deleveraging dynamics of the federal government and household sectors. Each line shows the change in debt (household or gov’t) to GDP, smoothed over four quarters.
In defense of the budget deficits that built up over the Great Recessions (and are now receding—Fig 4 here), the figure made the important point that as the household sector aggressively deleveraged, the public sector needed to leverage up to replace some of the lost demand.
But what’s happening now looks to me to be a timing problem: the pace at which the government is deleveraging (reducing deficits) is too fast relative to the household sector getting back in the game.
I’m not saying the slopes should be equal (in absolute value) and I can’t honestly say what a healthy rebalancing would look like (i.e., in this type of picture–re other indicators, it would clearly mean moving towards full employment much faster than we are). But I think the end of the picture, where I drew the arrows, is at least suggestive of the federal sector prematurely turning to deficit reduction while the household sector is too mired in high unemployment and weak paychecks to pick up the slack. My sense is you’d want to be where we are now well after we’d worked off the large output gaps that still persist in the macroeconomy, with GDP about 6% below potential and unemployment at least 2.5 percentage points above full employment.
This issue of the timing of government policy over the crash has perhaps gotten too little attention relative to the issue of magnitudes. I always thought the problem with the stimulus, for example, was less its size and more its duration. Part of that was a function of policy makers thinking we could go back to the well if needed, only to find that path blocked by anti-Keynesians.
Sources: Flow of Funds, NIPA