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Two good posts on budget deficits

Both Matthew Yglesias and Karl Smith (guest blogging for Ezra Klein) posted today on deficit spending by the federal government. They both dismiss the idea of opposing budget deficits for reasons of morality or responsibility and instead discuss them in terms of their impact on economic growth, which is the only thing you should really care about. Debt is a tool that can be used to make you (or America) better or worse off depending on the terms of the loan and what you do with the money you borrow.

Here’s Karl Smith:

So, deficits do matter. When the economy is strong, they lead the Federal Reserve to raise interest rates, strengthen the dollar and increase imports. When the economy is weak they lead to falling unemployment and rising capacity utilization.

Matthew Yglesias points out the negative effects of deficits, which under certain conditions:

In the real world, though, deficits matter for a specific reason. If the government tries to borrow a huge amount of money, investors will start demanding generous interest rates in exchange for lending. And if investors can get high rates lending to the government, which is safe, they’ll start demanding even higher rates of non-government borrowers. That becomes a problem for the private sector. Investments that are profitable at a low rate of interest are unprofitable at a high rate of interest, so the overall pace of investment and growth declines. Bad. The Federal Reserve can, however, act to keep interest rates low. The problem with this is that Fed action to lower interest rates might produce too much inflation. Inflation, when it gets high, is not just annoying but starts to really erode the workings of the price system and thus the whole economy. Again: Bad.

He then goes on to point out that the conditions under which it is bad for the federal government to engage in deficit spending are not currently in effect.

This is why just about every credible economist I read says that what the government needs to do is borrow money to stimulate the economy now and make a credible promise that it will cut the deficit later. For example, here’s Nouriel Roubini a couple of weeks ago:

The Obama administration did the right thing early, and avoided another depression. He is still doing the right thing now in pointing out the risks of early austerity. And he is limited by an unco-operative Republican party trapped in a belief in voodoo economics, the economic equivalent of creationism. Even so, he and his party have been unwilling to tackle long-term entitlement spending. Two years in, and this means the US remains on an unsustainable fiscal course.

The result will soon be the worst of all worlds: neither short-term stimulus nor medium-term fiscal sustainability.

5 Comments

  1. Since this recession began in December ’07 we have deficit spent to the tune of $4.5 trillion (and change). How much is enough? Serious question.

  2. How much of that $4.5 trillion has been stimulative in any way? A huge portion of it is just continuing current programs despite revenue shortfalls due to recessions. A big chunk of it has been spent on wars. Then there’s the part of it is due to tax cuts.

    That said, I don’t really know how much is enough. But I know that the only way out of our deficits long term is robust economic growth, and the priority for the country ought to be restoring robust economic growth as quickly as possible. I know that turning to austerity right now is not going to restore economic growth, and we’ll be living with 10% unemployment and massive underemployment for probably a minimum of 10 years.

  3. When I see that the fed over the past two years has purchased $1.7 trillion in treasuries and planning to purchase another $600 billion or so, I have to think that the market has started to say no to this level of deficit spending.

    I think the best way forward would be figuring out what is holding back private industry and remove those barriers. Additional government demand (and stimulus) isn’t going to lead to economic growth. As we are now seeing with the phase out of the stimulus, all of the “jobs saved or created” are going away as the states have no cash to keep the “saved” jobs and government contractors have no demand to keep the “created” jobs.

    It’s also worth noting that since 2000 we’ve added done around $9 trillion in deficit spending. How has that worked out for us? In my opinion, those trying to fight fiscal sanity by complaining about “austerity” really seem to be saying “don’t cut my programs”. I have a much darker view that 10% unemployment for 10 years if we do nothing, which is the path we seem headed down especially since it appears that Obama has given in on the Bush Tax cuts and is going to remove $3 trillion in revenue without any spending cuts.

    I’m actually heartened by the Deficit Commissions recommendations. I didn’t expect much of them since the Democrats got to pick 2/3rds of the members, but most of their recommendations are things I’d support.

  4. The republicans indeed ran up the national debt by almost $9T in the Bush administration. It’s amusing to watch the GOP raise this as a problem now.

    The problem is, it is a long term problem. Projections out to 2014 have the debt growing to $18T or more:

    http://en.wikipedia.org/wiki/United_States_public_debt#History

    This is clearly not sustainable as a long term strategy.

    My primary fear is not the Obama administration incrementally adding to the debt now, though. Additional stimulus seems clear to me to help, especially if it takes the form of direct job creation programs by government agencies. It worked for FDR and Truman; hell, it worked for Ike. It would probably work now.

    I’m more afraid of what happens in 2012 when the GOP takes the senate and maybe the presidency, and then goes back to their happy borrow-and-spend ways.

  5. (should read, “to” almost $9T in my previous post, However, much of the previous debt was run up by the Reagan and GHWB administrations of course; Clinton had a budget surplus when he left office)

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