Colleagues: Some time back I sent out a point paper on the U.S. debt and deficits, arguing that reducing these vulnerabilities should be one of our highest national security priorities. The paper laid out the rapidly expanding national debt (over $14 trillion); the projected deficit ($1.5 trillion) in this year’s budget, the rise of interest costs, and implications for American power and influence.
Most agreed, albeit not so many were willing to take reductions of entitlement benefits—Social Security and Medicare, most prominently.—to reduce the debt. There was some agreement on reducing defense spending, or at least the rate of growth.
A few were also in basic disagreement on deficits. Not that they “don’t matter”, but that during recessionary periods such as the present, and especially in the 2007 time period, it was more important to provide a “stimulus” for the economy, even at the expense of further expansion of the debt. I don’t disagree that such infusions help, but worry that we can’t simply print money forever, or expect foreign nations to continue to purchase our fiscal instruments when the country is so deep in debt.
The resort to deficit spending begun in the George W. Bush administration accelerated under President Obama. We don’t know whether such spending prevented a catastrophic collapse of the American and global economies, or whether the measures just drove us further into debt. The President will address that question today, certainly not announcing any new stimulus measures this time, but focusing on debt reduction initiatives. That turnaround itself could be politically explosive!
I asked those opposed to my “the deficit is a critical problem” to provide a counter point paper. Prof Elliott Parker, himself a “deficit hawk” but a proponent of infusions to resuscitate the economy, provided the following thoughts. I think he makes many points that are worth considering seriously, especially in arguing that the stimulus/deficit spending prevented the nation from falling into a massive depression, that the tax cuts for the wealthy are primarily responsible for the large deficits we are now running, and that Obama’s primary goal going forward should be not so much to reduce the deficits, but to insure that the economy grows faster than debt does.
Dr. Parker writes:
“The aspect of the current discussion on the federal deficit that aggravates me the most is its partisan and ideological nature. I have been a deficit hawk since they (deficits) exploded in the 1980s, but I don’t think deficits that result from tax cuts are somehow more virtuous than deficits that result from spending increases. Further, I think the problem is not just public debt, but private debt as well. I was gleeful when deficits turned into surpluses by the late 1990s, and I remember well my annoyance when Greenspan testified before Congress to argue against paying off the federal debt.
In general, I think borrowing makes good economic sense in two cases: when we can make purchases that return an income stream or a use stream over time, and when we need to smooth out the effects of a temporary drop in income or rise in expenditures. But what we saw prior to this recession was an explosion of public and private debt during good times, and the misuse of this debt helped lead to the collapse. As a nation, we spent more than we produced, borrowing the difference in effect to pay for unsustainable trade deficits. I think you should save more, not less, when the economy is doing well, and this applies to the government as well as households.
But I opposed the proposed balanced budget amendment. I thought it was dangerous, in that it would force spending cuts and tax increases during recessions, and encourage unnecessary spending increases during booms. We see this happening in Nevada now in the negative; it is macroeconomically destabilizing, and it forces choices that are microeconomically foolish. Most people don’t seem to understand that it is also important to generate a small federal deficit over time, since the expansion of federal credit is needed to back up the money supply so it can keep pace with the economy.
I think the primary reason for the current structural deficit is the extension of the tax cuts, and the primary reason for the future one is growing health care costs. The cyclical portion of the current deficit is temporary, and will soon fade. Tax revenues fall during recessions, and the administration added to this with a variety of temporary cuts. Expenditures have risen with the 2008 bank bailout (most of which is being repaid) and the 2009 two-year stimulus (especially the funds that were given to or lent to states, to ease their need for more tax increases or spending cuts), as well as with other spending that normally rises during recessions.
This recession was simply extraordinary, and I have argued elsewhere that it was a depression averted, not a garden-variety recession extended. The intervention was extraordinary, but given the potential downside I think it was called for. The potential long-term effects for national income were so large and so threatening, that even a very large short-run deficit would have a positive social return. We will never know for sure what the counterfactual was, what would have happened without intervention, so we will never have certainty over how effective the different parts of the stimulus were. The Blinder-Zandi estimates, I think, are reasonable, and a good effort at quantifying the effects of the different parts.
There are some who think that the stimulus should have been bigger. I think the political constraints made this the most that could be done, and I think the negative consequences of the financial crisis were not entirely avoidable, that this would be a painful time no matter what we did. I do think that from the macroeconomic perspective, the most effective part of the stimulus – apart from TARP, which was critical – was the bailouts for the states. The economic effects of state and local governments are in aggregate much bigger than for the federal government, and in 2009 they cut spending by the largest portion of GDP since the Great Depression, slowing the recovery. I think it is much more macroeconomically effective to prevent particular spending declines – public or private – than to increase spending in other areas.
I think people also don’t really understand that in a depression, as the Federal Reserve becomes the lender of last resort, the federal government becomes the borrower of last resort. There is a reason that T-Bill yields fell so low, because financial institutions of all sorts fled from risky assets into the safest of all assets. It is one reason why the Dollar has not depreciated as it should have.
There are those who call for more stimulus spending now, and I am not in agreement. I think that ship has sailed, and I think we need to now gradually bring the deficit back down, without doing anything dramatic that could cause a double dip.
But I think current efforts are a joke. Congress extended the tax cuts for two more years, as if that was somehow unrelated to the deficit, and the hypocrisy of that move was staggering. Congress is now trying to cut from discretionary nondefense spending, and the Administration froze pay for federal workers. While I am not opposed to cuts or freezes, if programs are not socially productive or workers are overpaid, I think the magnitude of these cuts are trivial. The real meat is in Medicare costs and Medicaid support, and in the defense budget, but nobody wants to do anything about all that. Maybe that is for the best for the moment, since big cuts combined with the expiration of the stimulus package could dampen an already slow recovery.
As an aside, while I think Social Security is of second-order importance in the whole deficit debate, I do think that adjustments in retirement age and other reforms are reasonable responses to the fact that Americans live longer now than they did when the system was designed. And I do like the idea of programs to encourage more private savings, so that social security becomes a less important part of the retirement system over time. But the real budget busters are that we pay less in taxes, as a share of our income, now than any time since the late 1940s, and the fact that health care costs rise by double-digit annual rates.
Our goal does not need to be to eliminate the federal debt, or even deficits, but instead to get the economy to grow faster than the debt, so that the ratio falls over time. We also need to pay attention to private debt as well. As we emerge from the crisis, Americans need to save and invest more, and consume less, and export more than we import so we can start paying down what we have borrowed from abroad. Unfortunately, this will be difficult given the relative attractiveness of U.S. assets and the slowing recovery in other countries which were much more conservative in their stimulus efforts.”
Many thanks, Elliott, for this very perceptive and thoughtful response.
Ty