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Old 02-22-2010, 12:30 PM   #113 (permalink)
dippin
Crazy, indeed
 
Location: the ether
Quote:
Originally Posted by aceventura3 View Post


This goes off point. The federal deficit had virtually nothing to do with the financial crisis. It is very common for an economy in war to increase its debt. And deficit spending as a percentage of GDP was in line with historical averages. Even with the tax cuts, taxes collected went up. The real problem with the deficit is spending and the accounting tricks used to raid social security.
The federal deficit during the Bush years had A LOT to do with the financial crisis. Part of the reason a bubble was created was that the need to finance that deficit led to a huge influx of foreign money into the US, helping foster excess liquidity, risk taking, and inflating the bubble.

From a 2005 paper by Menzie Chinn:
Quote:
Right now, nonresidents (foreign firms, individuals, and governments) are funding America’s budget deficits. In the absence of action, the government’s financing needs will increase over time, meaning that more debt will be issued at a faster and faster
pace. Foreigners do not have an infinite appetite for Treasuries, so yields will have to rise.
As more U.S. government debt is dumped into financial markets, either U.S. interest rates will rise relative to foreign interest rates after accounting for expected depreciation, or the dollar will plummet...
How will this play out in the broader economy? With interest rates spiking, the housing sector will experience a sharp correction. Since much of the typical American household’s wealth is in the form of housing, less wealthy consumers in particular will suddenly be forced to cut back on their spending. The weakening dollar will put upward pressure on import prices, which will then confront the Fed with a choice between accommodating the shock and stifling inflationary pressures. To the extent that the Fed opts for greater price stability, interest rates will have to rise by even more. All of these events will result in a deep recession.

As far as the size of those deficits go, the problem wasn't the size itself, but that they came during an economic expansion. Deficits are and should be bigger during a recession, but when you have deficits during an expansion, it only makes the recovery from the next recession that much harder.
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