(This guest post originally appeared at New Deal 2.0)
Criticism of extensive efforts of the national government to address – and overcome – the current economic emergency has taken on essentially three forms: on philosophical grounds (that the stimulus and the bank bail-out represent unwarranted compromises of the free enterprise system), on policy grounds (that they will result in dangerous budget deficits and increases of public debt) and political grounds (that they are sell-out to the banks and special interests). Of the three critiques, the one relating to fiscal policy is generally regarded by conventional wisdom as the most serious. The argument is that increased budget deficits and national debt are unsustainable and will harm the national economy more than they will help. This position is, at best, factually wrong and exaggerated. At worst, it fails to take into account the elementary distinction between the short-run cyclical and the long-term structural condition of the economy.
The federal budget deficit for 2009 and 2010 is estimated to be between $1.5 – 2 trillion or in excess of 10% of GPD. This exceeds the existing peace time record of 6% set in 1983. The corresponding figures relating to the national debt reflect that, in the 1990s, the ratio of national debt to GDP peaked at 50%, then fell to 33% in 2001, its lowest level for the preceding 20 years. It is estimated to go to 60% in 2010, its highest level since 1950.
While most critics of federal spending to contain the financial and economic crises seem to decry any spending which increases the deficit, it must be acknowledged that estimated levels of both the deficit and national debt are large in historic terms. However, it is not the size of the deficit/public debt in either absolute or relative terms that matters, but rather its actual or prospective economic effects.
To begin with, the size of the deficit (and projections for the debt) attributable to the economic recovery program are overstated for the period after 2010 and fail to take into account their short-run cyclical behaviour and the impact of renewed growth in 2010 and thereafter. The deficit consist of both increases in spending addressing the economic crisis and declines in tax revenue caused by the downturn. Both this type of spending and tax revenue declines are temporary. Once self-sustaining growth, resumes, these two variables reverse. Thus, renewed growth will naturally result in dramatically lower deficits (all things being equal).
Whatever the net numbers after 2010, possible adverse effects of the deficit/national debt basically involve impacts on interest rates, the dollar and inflation. The possible effects on interest rates could be both short-run and long-term. It has been said that the deficit might raise bond yields now before a self-sustaining recovery sets in, thereby choking it off. In the longer-run, it is argued that interest rates might go up because a persistent deficit would cause inflation or because of “crowding out” of private investment as available funds are soaked up by financing of the public debt.
Neither prospect seems particularly likely or evident in the next 5 years. As to the short-run, the suggestion is that the market for U.S. Treasury obligations will be inundated by new financings and will require much higher interest rates for Treasury obligations to sell. But current weak economic activity is dominating the Treasury market, and interest rates are at rock-bottom levels. As the last interest rate cycle demonstrated, this situation can persist indefinitely until the Fed decides to lift short-term interest rates.
As to higher inflation, to be sure, the Fed has taken extraordinary steps to supply liquidity to the financial system, including engaging in a type of quantitative easing. The argument appears to be that these actions have resulted in an extraordinary expansion of the money supply, which is necessarily inflationary. We should be so lucky. For the foreseeable future, deflation– not inflation–is the problem. Generally, expansion of the money supply– even a radical expansion–will only produce inflation when the economy is at full employment.
It has also been argued that the deficit and/or sovereign indebtedness of the U.S. will inevitably cause a dollar collapse and foreign capital flight, thereby also raising interest rate and choking off growth. However, there is little evidence, thus far, for these effects. Indeed, the global financial and economic crises have affected other currencies more adversely than the dollar. The dollar collapse argument really amounts to the proposition that the U.S.’s already-heavy reliance on external financing cannot absorb additional substantial burdens. Although a complex subject, the external financing requirements (previously to finance the U.S.’s current account deficit) are in flux, as the U.S. is in the process of rebuilding its national savings rate and curbing its imports. Heightened national savings also suggests that financing of public debt will not crowd out private investment, either.
As the above demonstrates, there is currently no credible case that steps of the national government to meet the national economic emergency, by themselves, will cause more harm than good, let alone will cause the much ballyhooed economic calamity forecast by critics of the economic stimulus and the bank bail-out. Indeed, far from representing fiscal irresponsibility, they are designed to–and have been effective in–staving off economic calamity.
This is not to say that deficits and public debt loads could never adversely affect the U.S. economy in the foreseeable future. At most, and, indeed, only in conjunction with other unpaid-for federal spending could the cumulative effect of spending to save the economy constitute a problem. Moreover, there is no red line danger point beyond which deficits or national debt create a so-called deficit/debt “wall” which will stop the economy in its tracks. Most serious studies show that we are a long way from that point.
There is, however, one aspect of the deficit /public debt problem which must be considered. The Obama Administration has not been budgeting and spending on a clean slate. Rather, it inherited a large structural deficit from the prior Administration. Indeed, at least half of the record 2009-10 deficits are attributable to Bush’s cynical and reckless economic policies which involved running large deficits during periods or prosperity. These deficits of choice involved two wholly avoidable policy fiascos: The Bush tax cuts and the Iraq War–Bush’s two signature policy initiatives which were never paid for.
In addition to contributing half of the deficit and debt increase at their peaks, the tax cuts and increased spending of the Bush years when the economy was at full employment represent fiscal irresponsibility in the extreme. Imagine where we would be now if substantially or even part of the $5 trillion surplus accumulated by the Clinton Administration had been available to handle the economic emergency.
The Republican Party intentionally advocated full employment deficits for political reasons; i.e. to force a wholesale abandonment of federal spending except for national defence –the single most wasteful spending item in the budget–by creating an artificial fiscal emergency which would impose forced spending reductions. Unfortunately, the Republicans did not anticipate the financial crisis and the ensuing economic emergency that their reckless economic policies were directly responsible in causing. By creating the artificial emergency, the Bush budget deficits–and the frittering away of the surplus– have undermined the political will of the nation to stave off and exit from the economic downturn and to do what is necessary to ensure the resumption of acceptable rates of non-inflationary long term growth–exactly what the Republicans wrongly decry about the federal stimulus and bank bail-outs. Such obvious hypocrisy and sophistry does not deserve to be taken seriously from a policy perspective. It should be regarded as pure political posturing which has sacrificed the national interests to efforts to cling to political power.
In addition to factual and policy misconceptions about the likely effects of the deficit and national debt over the next 5 years and the historical amnesia of the deficit hawks, current criticism of government spending and budget deficits essentially ignores or conflates short-run cyclical and long-run secular effects. As noted, the deficit will shrink as a result of renewed self-sustaining economic growth which will necessarily raise tax revenues. Indeed, it is a prerequisite for regaining control over both the deficit and the debt as demonstrated by the Clinton years. At that point, we will be left to contend with the structural deficit created by the Bush tax cuts and bequeathed to the nation by Bush and the Republican-controlled Congress. Oh, remember them? That is why it is absolutely essential that the Bush tax cuts be permitted to expire.
At some point, there needs to be a serious conversation between the responsible part of the political leadership in this country and the public about fiscal responsibility and taxes.
Roosevelt Institute Braintruster Daniel Berger is an attorney in the field of complex litigation, including securities and anti-trust litigation, and has a broad-based knowledge concerning the structure and functioning of the US economy and US financial markets. He practices in Philadelphia.