Professor John T. Harvey, TCU, on Govt Spending

I'm surprised to see it spelled out this clearly in Forbes of all places! Highly recommend: this great, easy-to-read post covering the basics of GDP and the relationship between private investment and government spending. I might carry around hardcopies of this and demand it be read and understood before agreeing to even discuss the economy socially. (Yes, I am well on my way to curmudgeonhood.)

Some choice excerpts:

The government’s plan? More layoffs and wage reductions. This is supposed to encourage entrepreneurs to take the risks about which they are reluctant at the moment. If that seems illogical to you, it’s because it is. It’s sheer lunacy.

OR

Since investment is a major driver of the business cycle, look at what happens:

fall in investment => fall in GDP => increase in government spending

The last entry at least partially compensates for the first, which makes recessions less severe and lengthy. This has dampened, if not eliminated, the effect of the private sector’s instability since WWII. And it works in reverse, too:

rise in investment => rise in GDP => decrease in government spending

Hence, as the economy grows, so the government budget tends toward balance (as it did at the end of our longest peacetime expansion in the 1990s).

But, and this is terribly important for today, the line of causation does not run in the opposite direction!!! It is not true that lowering government spending has a tendency to increase investment. Unfortunately, this appears to be the basis of a great deal of policy in Washington today (assuming there is any economic logic to it at all). Taking discretionary action to cut spending now will be an absolute disaster. We haven’t even started doing that with any gusto yet, and look at the results from 2011Q1. And, just today, President Obama signed a bill that cut $38 billion from the government budget, while the house passed one reducing government spending by $6.2 trillion over the next decade. This is absolute insanity.

What do these people think is going to happen?