Wednesday, July 1, 2009

Let's Not Forget

Matt Yglesias writes today about a Washington Op-Ed regarding the budget crisis in California. Yglesias makes an important point:

Even the whole “green shoots” debate is really about whether we can expect things to be somewhat better or somewhat worse six months out from now. In either case, things really are really bad right now. And a whole bunch of states including large ones like California and Pennsylvania—are soon to implement substantial cutbacks in services at just the time when the objective need for social services is going up.

The near-term fiscal pressures state and local governments will face is one of the things that concerns me most looking at the economy moving forward. Most of these governments are required by law to balance their budgets. As tax receipts fall, cuts must follow. Although there's certainly an argument to be made that many state and local governments are bloated, a period of economic distress is an inopportune time to reduce spending. Cuts by these entities have the potential to counteract any spending increases by the federal government and send our economy plunging.

One only needs to look at the Great Depression for proof. Most high school history classes teach you that the federal government used the New Deal to boost the economic recovery. What they fail to mention--which you can see below--is that state and local governments ran surpluses to balance out the federal spending. If my memory serves me correct (I can't find the actual numbers), federal, state, and local governments ran an aggregate SURPLUS for most of the Great Depression, with the state and local governments essentially nullifying any impact of FDR's fiscal stimulus. Only during World War II did the U.S. finally return to producing at its maximum capability. I really hope we don't forget that lesson.

Source: Econobrowser

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