Stimulus and Recession in Simple Terms

I studied Economics in University, though my marks would indicate that I didn't attend many classes or read much of the material.  Nonetheless I find myself reading economic reports on a daily basis as a part of my job.  I often wait with bated breath for various reports that are released at 830 am.

This brief issued by the non-partisan Congressional Budget Office makes for some sober reading.

http://www.cbo.gov/ftpdocs/116xx/doc11659/07-27_Debt_FiscalCrisis_Brief.pdf

To make a long story short, soaring deficits may cause debt to reach crisis levels.

At this point I think that its helpful to simplify things so that the dimmer lights who occupy all parts of the political spectrum can understand.

If we borrow $100 to 'stimulate' the economy through tax cuts, infrastructure spending, etc, etc.......there comes a time when we need to pay it back.  If it's in one year then we will need to pay back about $102.  If its in 5 years we will need to pay back $110.  (I have assumed away compounding to keep it simple, and assumed an interest rate of 2%).  Paying that back means increasing taxes by $110 or cutting infrastructure spending by $110 or reducing social services by $110.....or some combination thereof.

The math is very simple.....to "stimulate" the economy with a $100 deficit means reversing the stimulus by more than $100 since we will need to pay interest.

This example makes some very poor assumptions that are helpful to the arguments for deficit stimulus spending.

1. I have made the bad assumption that $100 of stimulus will actually result in $100 of 'value' and that none will be lost due to inefficient allocation.  This is a very poor assumption.
2. I have made the ridiculous assumption that there is no compounding of interest.  The reversal of stimulus would be much greater if interest is compounded.
3. I have made the assumption (nay fantasy) that the deficit will be repaid in 5 years.....an appalling bad assumption.  Just how bad would the pro-deficit argument look if we assume that it takes 30 years to pay it back?  Even 30 years is a very rosy assumption.
4. I have made the assumption that there is no "crowding out" effect where government spending incents the private sector to spend less.
5. I have made the assumption that the expansion of the government into a greater share of GDP does not result in inefficiencies.  

Despite all of these very rosy assumptions that are helpful to the pro-deficit view, we are left with the simple math that says that $100 of stimulus will result in a reversal of $110 of negative stimulus over the next 5 years.

I have ignored one giant elephant in the room and that is the multiplier effect.  It is the idea that when the economy is stimulated by $100, it actually results in increased economic activity of a number greater than $100....say $160.  If this is uniformly true then the argument for stimulus is stronger.......except that I have never understood why the multiplier effect doesn't also work in reverse when the stimulus is withdrawn.

I once heard a saying that the only role of Economic Projections is to make Astrology look respectable.  (I would provide the citation if I could remember where I saw it.)  If we can't accurately predict the path of GDP, then I don't understand how we could possibly predict a secondary derivative like a multiplier effect.

If the multiplier effect is valid, I also don't understand why we don't favour ever higher deficits as the path to endless prosperity.

To borrow a phrase from George H.W. Bush....a lot of this is Voodoo Economics.  The truth is that our current deficits are just a way to pay for the standard of living to which we have become accustomed by raiding our children's education fund.  

Our leaders have failed to speak some basic truths to the people.  Hard times are necessary.  Recessions are bad and so is death......but both are necessities in the grand scheme of things.  No society has ever achieved 100% employment and no society ever will and it's not necessarily a good thing to strive for.

After 9-11, George W. Bush implored people to go shopping and enjoy life because otherwise Al Quada wins.  I can't recall another time in history when a nation went to war and simultaneously went out for dinner and a movie.  That attitude still permeates society.  

Hard times build character.  I treasure the memories of a childhood without material excess.  I recall eating a piece of (what I now know was terrible) cheese on a plane as we immigrated from Korea.  I realize now that our diet in Korea must have been very very low in fat.  I declared that cheese the best thing I had ever tasted!!

I couldn't possibly bring myself to impose a false poverty on my son so that he can learn about what life is like for so many.  However I do feel sad that he will probably never have such experiences.  Although if we keep spending money we don't have, then he and many other children of today will have those experiences in reverse...and that would be tragic and represent a failure on our part.