This piece originally appeared on CNN.com
Casual observers of budget politics (that is, most voters) may know that the experts in such things are very concerned about rising public debt. They have also probably heard much talk about the “fiscal cliff” the nation is headed for in 2013.
What they might not know is the real danger is that public debt will stop rising quickly. That cutting spending and raising taxes to slow the growth of debt will cause spending to fall across the economy and bring about a new recession.
Conventional wisdom says simply that we need fiscal stimulus now, and long-term debt reduction later.
It sounds reasonable enough, and I may have even believed it myself a couple of years ago. But it turns out to be wrong.
The two imperatives of immediate stimulus and long-run debt reduction are deeply asymmetric. Every day we don’t act to bring down the unemployment rate quickly is another day of human misery and pure economic waste. Since the Great Recession began, the nation has foregone more than $3 trillion in potential income because of idled resources (people and factories). In 2011 this “output gap” exceeded $800 billion again, and the first quarter of 2012 saw us move nowhere toward closing it.
But the surest way to lower unemployment quickly is to add to public debt to finance job-creating measures like aid to distressed households and states and infrastructure investment. And so long as the economy is operating below potential, the additional debt does no harm to the economy.
This is textbook macroeconomics. The danger that budget deficits theoretically pose to economies is that in order to borrow, government must find lenders, which means competing for the scarce savings of households and businesses with private firms looking to borrow money to invest in plants and equipment. This competition can bid up the price of borrowing (interest rates) and private firms will hence forgo some of these productive investments.
So why doesn’t this story apply to the United States today? Because there is no discernible upward pressure on interest rates. And that’s not a fluke—remember that it was the scarcity of savings relative to desired investment that drove interest rates up in this scenario. But, savings today aren’t scarce—households continue to save and pay off debt (that “de-leveraging” that you may have heard about) and businesses have accumulated record amounts of unspent liquid assets. This glut of savings relative to desired investment has put relentless downward pressure on interest rates.
So, if today’s deficits are doing no damage (and in fact are supporting job creation), why the frequent insistence that further stimulus is allowed only if it is matched by long-run deficit reduction?
I don’t know.
What makes it especially puzzling is that the current law of the land is completely sustainable from a fiscal perspective—the long-term budget outlook released by the Congressional Budget Office this week shows falling debt to GDP ratios for most of the next 75 years.
Fiscal hawks will cry “foul” on this. I’m referring to the “current law” baseline. But, everybody knows that this current law will not be followed—most of the Bush tax cuts, for example, set to expire at the end of 2012 will surely not. These hawks point instead to the “alternative fiscal scenario” baseline, which shows the scary-looking long-run debt trends that people are familiar with.
But step back a second—the hawks insist that we legislate changes to make the long-run debt path look less scary. But we’ve done that—that’s the “current law” baseline. Yet this doesn’t count as “doing something” about long-run deficits because nobody believes this law will be adhered to.
Fair enough—I don’t believe it either. But just what is the budget law that we will pass this year that will convince everybody it will hold 75 years from now (the projection period of the long-term budget outlook)? After all, doesn’t the entire long-run budget problem today stem from people thinking that current policies instead of current law will continue; that is, isn’t the whole problem that people think Congress can’t help but change the law in ways counter to long-run budget balance?
Surely we can’t hold stimulus hostage to the requirement that Congress promises to stop ever again acting like, well, Congress?
We’ve lived with high unemployment long enough that it may not seem like a crisis, but today’s unemployment rate of 8.2 percent is just that. It may be a marked improvement from the recession’s 10 percent peak, but it remains higher than at any point in the quarter-century before the Great Recession. Growth forecast over the next couple of years will not be sufficient to move it down quickly.
Maybe a dumb analogy will help: Your house has drafty windows and doors that may cost you money in higher utility bills, but it’s also on fire. Somehow, though, you decide to douse the flames only after a contractor is lined up to do some caulking. Does this make any sense at all?