My grandmother's recipe for spaghetti sauce goes, in part, something like this:
“Combine ingredients in a saucepan on high heat and bring to a boil. Reduce heat and simmer … “
Managing the economy is sort of like making spaghetti sauce. The sauce is the economy, and its temperature represents its output, as compared to its potential. (Think of the temperature in celsius, where 0 is freezing, and 100 is boiling. That scale maps well to many economic variables.) The stove is the government, the gas is the government deficit, and the kitchen is the rest of the world. Simmering represents the economy operating at full potential, but without overheating.
If the sauce ingredients start out at room temperature, you can turn the gas up all the way, and keep it there for quite a while, with no danger of the saucepan boiling over.
Likewise, when the economy is operating with lots of unemployment and excess capacity, like it is today, we can have very large deficits with no danger of inflation. In fact, we have so far had deficits of record-breaking size for 4 years running without any increase in inflation, and the economy is still nowhere near our goal of “simmering”.
As the sauce temperature approaches 100 degrees, you have to reduce the heat, or the sauce will boil violently, boil over, and make a mess. Likewise, when the economy gets near full employment, you will have to reduce the deficit, or the economy would “overheat”, and cause inflation.
But, you can't turn the gas off completely, and expect the sauce to continue simmering. The sauce is constantly losing heat to the kitchen, and will cool off if the gas is turned off completely.
Likewise, you can't balance the budget (no deficit) and expect the economy to continue operating at capacity. It will lose money to the rest of the world, because of the trade deficit, and the result will be a recession. Economists call this loss of money from the economy a “leakage”, and it is just like heat transfer from something hot to its cooler surroundings.
In order to keep the sauce just simmering, without cooling off or boiling over, the gas must be on at just the right level to offset the heat loss to the kitchen.
Likewise, to keep the economy operating at peak level, there needs to be a deficit just large enough to offset the leakages to the rest of the world, and also domestic savings, which is another leakage. (I have no analog in spaghetti sauce for domestic savings, which just proves that no analogy is perfect.)
Reducing the gas before the sauce has come to a boil means it will take longer to boil, or may never boil, if the gas is not high enough to offset the heat loss to the kitchen.
Likewise, reducing the deficit today, when the economy is so far from optimal, and not even moving noticeably in the right direction, is a recipe for recession, with no hope of ever getting back to full employment.
The Treasury is the supplier of money to the economy, just as the stove is the supplier of heat to the sauce. Nobody else can create the dollars needed to raise GDP, and if government refuses to have a high enough deficit, refuses to create dollars in sufficient quantity, we will continue to suffer as we have for the past 4 years.
