Krugman overstates the impact of federal spending cuts

According to Paul Krugman, the U.S. unemployment rate would be less than 5.5 percent if only discretionary federal government spending (everything outside of entitlements and automatic stabilizers such as Medicaid, food stamps, and unemployment benefits) since 2007 had grown at the same rate as it did from 2000 through 2007. I have great respect for Professor Krugman and sympathize with his views on the government’s counterproductive fiscal stance over the past few years, but this particular argument doesn’t hold up.

To support his case, Krugman made the following chart using data from the Office of Management and Budget:


(Source: OMB historical data, table 8.7.)

From this perspective, federal discretionary spending would have been about 42 percent larger than what will actually happen in 2014. That is hundreds of billions of dollars that would have filtered through to the rest of the economy.

Unfortunately, those numbers are misleading on several levels. First, Krugman didn’t adjust for inflation. Prices rose more slowly in the more recent period than in the later one. What really matters is the change in inflation-adjusted spending. Luckily for us, the OMB measures inflation-adjusted discretionary spending in table 8.8. Here is my reproduction of Krugman’s chart above, except that I used a more relevant data set:


There is still a gap between what spending would have been and the actual level of spending, but that gap has shrunk by about half.

This isn’t the whole story. The single biggest component of federal discretionary spending goes to the military and the intelligence agencies. Whether or not you think the U.S. spends too much or too little on defense, it should be obvious that this spending rises and falls according to national security imperatives more than debates about austerity. In the aftermath of the terrorist attacks of September 11, 2001, the U.S. government dramatically expanded its spending on domestic security and also waged wars in both Afghanistan and Iraq. More recently, U.S. forces have left Iraq and, after a brief surge, are now leaving Afghanistan as well. This is the result:


To filter out this noise, I looked at the changes in non-defense discretionary spending, adjusted for inflation. Again, I reproduced Krugman’s chart format as much as possible in order to make a fair comparison.


There is still a gap between actual and hypothetical non-defense discretionary spending – about 9 percent – but it’s far smaller than what Krugman implied in his post. The dollar value of this gap is only about $67 billion. It’s hard to believe that the difference between full employment and current economic conditions comes down to so little money.


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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