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.