by From Dean Baker Debt and Deficits, Again With the possibility that the Democrats will retake Congress and press demands for increased spending in areas like health care, education, and child care, the deficit hawks (DH) are getting prepared to awaken from their dormant state. We can expect major news outlets to be filled with stories on how the United States is on its way to becoming the next Greece or Zimbabwe. For this reason, it is worth taking a few moments to reorient ourselves on the topic. First, we need some basic context. The DH will inevitable point to the fact that deficits are at historically high levels for an economy that is near full employment. They will also point to a rapidly rising debt to GDP ratio. Both complaints are correct, the question is whether there is a
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from Dean Baker
Debt and Deficits, Again
With the possibility that the Democrats will retake Congress and press demands for increased spending in areas like health care, education, and child care, the deficit hawks (DH) are getting prepared to awaken from their dormant state. We can expect major news outlets to be filled with stories on how the United States is on its way to becoming the next Greece or Zimbabwe. For this reason, it is worth taking a few moments to reorient ourselves on the topic.
First, we need some basic context. The DH will inevitable point to the fact that deficits are at historically high levels for an economy that is near full employment. They will also point to a rapidly rising debt to GDP ratio. Both complaints are correct, the question is whether there is a reason for anyone to care.
Just to remind everyone, the classic story of deficits being bad is that they crowd out investment and net exports, which makes us poorer in the future than we would otherwise be. The reason is that less investment means less productivity growth, which means that people will have lower income five or ten years in the future than if we had smaller budget deficits. Lower net exports mean that foreigners are accumulated U.S. assets, which will give them a claim on our future income.
Debt is bad because it means a larger portion of future income will go to people who own the debt. This means that the government has to use up a larger share of the money it raises in taxes to pay interest on the debt rather than for services like health care and education. Or, to put it in a more Keynesian context, there will be more demand coming from people who own the debt, which means the government would need higher taxes, to support the same level of spending, than would otherwise be the case.
There is an important intermediate step in the deficit-crowding out story that is worth stating explicitly. The Federal Reserve Board could opt to keep interest rates low by buying up debt directly. The assumption in the crowding out story is that the Fed allows interest rates to rise or even deliberately raises them, presumably because it is concerned about inflation.
If there is no basis for inflationary concerns, there is no reason that the Fed could not simply keep interest rates low in spite of a large deficit, and therefore prevent any crowding out. The question then is whether a budget deficit is pushing the economy up against its limits, leading to inflationary pressures. When we look at the various sources of demand in the economy, there are two reasons for thinking that a larger budget deficit would be needed today to sustain something close to full employment than would have been true four decades ago.