No, Government Hasn't Gone Up

Yeah, Krugman's been banging on this one for a while, but he linked to a great post by Menzie Chinn that shows the situation.

I've been lecturing on the government sector in my macro course. In updating my lecture notes, I plotted out some interesting graphs, which link up nicely with this previous post. The following four figures highlight: (1) normalized Federal outlays are not much higher than in 1986; (2) government consumption to GDP is back up to 1991 levels; (3) the cyclically adjusted budget deficit is only 2 ppts larger than that recorded in 1987; and (4) Federal consumption remains far below the previous peak in 2007.

One of the topics stressed in the textbook and lecture notes is the endogeneity of the budget balance, and especially the transfer and tax components. This leads to the first graph, of transfers normalized by nominal GDP, and transfers normalized by potential GDP...

...Notice that government transfers as a share of GDP looks particularly high because of the collapse of GDP in the Great Recession which started in 2007Q4. Normalizing by potential GDP highlights the fact that, while the ratio is the highest over the last forty three years, it is only slightly higher than that recorded in the mid-1980s, during the Reagan administration.

Normalizing government consumption and investment illustrates that overall spending by the government in purchases of goods and services is not particularly high. Even dividing by nominal GDP indicates that we are only (almost) back to the levels of 1990. Normalizing by potential GDP indicates that we are still only back to the levels of the early 1990's (this spending includes defense)...

...So, it is true that the Federal government's role in terms of spending and transfers has increased against the backdrop of a massive decline in output starting in 2008Q4 -- but some of the movements in various indicators are distorted by the large negative output gap that has opened up.

That latter bit is why I liked the post so much. Focusing on spending as a percentage of GDP is really prone to distortion. That measurement of spending as a percentage of potential GDP neatly removes that problem. It reinforces what I've known for a while: that you don't need to cut social spending. Just end the damned wars, end the Bush tax cuts, and end the recession. Do those things, and the budget falls neatly into place.