Sunday, October 05, 2014

Business-Cycle Conditions: Fiscal Policy Drag Diminishing

The Great Recession of 2008-2009 will be remembered for its severity—a cumulative decline of 4.2 percent in real GDP, the loss of 8.7 million jobs, and a harsh toll on the banking system with more than 400 bank failures from 2008 to 2011. The Great Recession should also be remembered for the massive increase in the federal budget deficit it spawned. As a percentage of GDP, the budget deficit reached 9.8 percent in fiscal year 2009, the highest since 1945 and the highest ever excluding the World War II period (Chart 1). Through another lens, the six-year cumulative deficit from 2008 to 2013 totaled almost 41 percent of GDP, well exceeding the total of about 26 percent for the six worst years of the Great Depression.

Statistical Indicators of Business-Cycle Changes

Like the proverbial double-edged sword, fiscal deficits can be both helpful and detrimental. The positive aspect is that the strong federal fiscal response likely helped initially to support the recovery. The negative side is that the nation’s cumulative debt position deteriorated, raising concern about the long-term outlook for the economy. In addition, very large deficits cannot be maintained indefinitely, and as expenditures are reduced, they tend to restrain economic growth.

More from the American Institute for Economic Research

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