New York Times columnist David Brooks went all out in heralding the “debt is evil” stigma in his column yesterday. Regrettably, this blanket condemnation of borrowing as intemperate or immoral, intergenerational theft is all too pervasive among Washington’s policymaking elite, and all too wrong: Not all debt is created equal and suggesting otherwise impedes sound fiscal policy.
Economic actors borrow money for a wide array of activities, and both businesses and households know better than to apply a universal value judgment to debt. Borrowing money for college tuition allows for human capital accumulation, which will hopefully yield a high rate of return; borrowing money to take to the casino is widely viewed as imprudent, as the expected rate of return at any casino is negative. Businesses borrow money to build factories, buy equipment, finance research and development, and engage in other productive activities that add value to the economy. Financial firms leveraging themselves the way of Long-Term Capital Management (using debt to proportionally magnify both risk and potential returns), on the other hand, adds systemic financial risk and zero—more likely negative—economic value. Similarly, there are good and bad reasons alike to run federal budget deficits. What matters much more than the accumulation of nominal debt is the purpose of the borrowing and the ability to repay the amount borrowed.
Brooks laments that the “federal government has borrowed more than $6 trillion in the last four years alone, trying to counteract the effects of the [dotcom and housing] bubbles.” Yes, the implosion of the housing market and the ensuing financial crisis and recession forced Congress to borrow heavily as the cyclical portion of the budget deficit ballooned and fiscal policy was used to arrest a steep economic contraction, propping up aggregate demand and the financial sector alike. The alternative, however, was a depression that would have swollen budget deficits regardless, while greatly impeding our ability to repay debt because of lost income and economic scarring reducing future potential income. Indeed, policymakers’ failure to restore full employment—which still necessitates much more deficit-financed stimulus—is producing such scarring effects: The U.S. economy is still running $861 billion—or 5.3 percent—below potential output and the Congressional Budget Office has downwardly revised projected potential output for 2017 by 6.6 percent since the onset of the recession. That is real, welfare-reducing economic waste resulting from insufficient public borrowing—borrowing that could have put productive resources to use instead of allowing them to atrophy.
Economists Lawrence Summers and Brad DeLong compellingly argue that given present U.S. economic conditions (where the Fed cannot singlehandedly stabilize the economy), deficit-financed stimulus is actually self-financing. Essentially, if nominal interest rates are below long-run trend real GDP growth adjusted for reduced economic scarring effects and improvements in the cyclical budget deficit resulting from stimulus, a dollar of debt more than pays for itself in the long-run. CBO projects real GDP growth will average 2.4 percent over the next 25 years, whereas the yield on 10-year Treasuries is only 1.55 percent (hovering around a record low); high bang-per-buck fiscal stimulus passes any reasonable cost-benefit analysis test so long as the economy remains mired well below potential in a liquidity trap.
What Brooks misses entirely is that any value judgment regarding debt boils down to the opportunity cost of debt and the value added of the tax or spending program being deficit-financed—particularly in ways that affect the ability to repay debt.
Example 1: The Bush-era tax cuts were entirely deficit-financed, adding some $2.6 trillion to the public debt between 2001 and 2010, while failing to produce even mediocre economic performance (the 2001-2007 Bush economic expansion was the weakest since World War II). Numerous economists believe that, between their dismal efficacy and the reduction in national savings they induced, the Bush tax cuts decreased long-run potential output.
Example 2: If the rate of return on infrastructure spending exceeds the cost of financing, it makes sense to borrow money to build a bridge, or better yet repair a bridge (the cost of repair increases with time and preventative maintenance is much more cost effective than rebuilding infrastructure from scratch). As my colleague Ethan Pollack points out, the case with infrastructure is a clear cut “win-win-win” because it raises potential future output, making the incurred borrowing relatively easier to pay back, and infrastructure spending increases actual present output and employment (reducing cyclical deficits). And today, the opportunity cost of infrastructure investment is at historic lows.
There is good debt and wasteful debt alike, just as both constructive editorializing and gibberish can be found scrawled across op-ed pages. Brooks’ failure to recognize any economic context or nuance only feeds the misguided debt hysteria that has pushed most of Europe back into recession and encouraged U.S. policymakers to give up job creation in favor of premature, counterproductive austerity.