If that course is followed, we would avoid the routine tight-money end of growth cycles because fiscal tightening would cool the economy. Phasing in deficit reduction today, to go forth over the next six years, is precisely the strategy to ensure that our recovery can go forward for years without running into inflation problems and the resulting urge by the Fed to put an end to growth.
Some public-sector investment is worth having. Defense conversion frees up resources to do just that but, hopefully, in a very targeted fashion and far away from potholes. We also have a heaven-sent opportunity today to clean out wasteful government by applying deficit-reduction strategy. Finally, for the first time in 20 years, interest rates are returning to reasonable levels. We need bigger deficits like we need a hole in the head.
There are also important initiatives to be taken in managing the public debt more effectively and at lower cost. One direction is to shorten the maturity of the debt, which today stands at a year high. In addition, we should certainly look at the possibility of issuing indexed debt. Better management of public resources is a more productive direction than ever-larger deficits.
Allan H. What matters most about budget deficits is how fast they grow, what they pay for, and how they are financed. Government, like everyone else, can finance its deficit by borrowing, but unlike the rest of us, can tax and print money. Inflation results when money grows faster than output does. Many countries have experienced high inflation because of budget deficits and excessive money growth. Borrowing to finance budget deficits can be useful if we use the borrowed resources productively.
If the large deficits of the s and s had financed productive investment, we would be richer now or in some way better off. To the extent that the Reagan deficits financed a military buildup that the Soviets would not and could not match, the world is now more peaceful, and we are better off.
Of course, we could have paid for the buildup with current taxes, but doing so would have concentrated the costs at a point in time instead of spreading them over present and future beneficiaries. A common argument against recent deficits is that they financed a consumption binge.
It is true that reported investment grew relatively slowly in the s, but published data are misleading. A larger issue is whether or not increased consumption is bad or should be avoided. It is not a cause for alarm if the public willingly chooses to consume more today than tomorrow. Most of us do just that when we buy a house and take out a mortgage. As a society, however, we should be concerned about biases in the tax system, in laws, in regulations, and in government spending that tilt spending toward consumption and against investment or that encourage borrowing and indebtedness.
If there are such biases, we should correct them in the interests of efficiency. The gain from increased efficiency is worth having, whether the budget is in deficit or surplus. Eisner performs an important public service by reminding us of two points that are usually overlooked in discussions of the budget deficit.
Second, relative to the size of the economy, current and prospective budget deficits, as measured, are well within our past experience.
Eisner then makes several points that are either impractical or misleading. A capital budget for the federal government is impractical. By calling expenditures such as these investment, a government can justify deficits of any size. A capital budget for government requires an independent authority to define capital and investment and ensure that accounting rules are followed. For society, government deficits, no less than private borrowing, reduce total saving.
Most of the fuss and noise about the budget deficit is not about deficits. It is about spending and redistribution. Many of the points he raises in support of this argument are difficult to refute and reflect the sound analysis of an experienced economist who has been examining this subject with a professional, open mind for many years. I want to comment on a few points that deserve closer attention and suggest that his premise might be modified to something more palatable: deficits may not be harmful if they are directly associated with specific, high-priority, economic restructuring activities.
I am in agreement with Eisner that the definition of the federal budget deficit needs to be standardized and made relevant to what it addresses. It certainly should, as a minimum, distinguish between current or operating outlays and capital expenditures; and the budget should include only the depreciation on past tangible investment, not current tangible capital investment.
Along the same line of thinking, those expenditures that are of a strategic nature and aimed at addressing near-term economic structural adjustments should be handled separately in the accounting. According to Eisner, if deficits add purchasing power and aggregate demand to the private sector, they are good. The fact of the matter is that our deficit should have addressed problems on the production side, not on the consumption side.
In terms of revenues, we need similarly to be careful to recognize the structural and strategic implications of tax proposals. The energy tax, for instance, does focus on an important structural problem, that is, how to change our national energy consumption patterns, encourage more investment in conservation, and develop alternative sources. What makes the world so nervous about the U. Furthermore, increasingly, foreign interests are handling the financing of the debt.
Hence, the whole world is watching us closely. Therefore, if the United States is to maintain its economic leadership role, it must give the world the confidence that whatever deficit it incurs is under control and directly related to financing effective solutions to important structural problems.
Harvey S. His analysis of problems in measuring the deficit is particularly compelling. Given the arbitrariness of any number that purports to be the deficit, it is silly to spend a lot of time worrying about whether or not the economy hits some particular target deficit. Despite the fact that it is difficult to measure, the deficit is a very important issue, in my opinion.
Nevertheless, it is only of second-order importance. The issue of first-order importance is the size and composition of government spending. Fundamentally, the burden of government on the economy is the amount of resources that the government diverts from the private sector.
The deficit is merely one possible mechanism for financing that transfer of resources. Other possible mechanisms are methods such as taxes, user fees, government confiscation of property, etc.
Deficit spending is probably worse than some taxes but better than others. It is easy to think of measures that would lower the deficit and still make the economy worse off. For example, lowering the deficit by increasing our highly distortionary corporate income tax might lower the overall efficiency of the economy.
If the answer is yes, then we should be happy to raise taxes to finance that spending or, perhaps, to finance it by borrowing. In contrast, I think these issues should be central to the debate. In short, I agree with Eisner that our obsession with the deficit distracts attention from the really important issue. With more expansionary fiscal policy, we could have easily returned the economy to pre—Great Recession levels of unemployment by Instead, the unemployment rate averaged 7.
As long as growth is demand-constrained, budget deficits should not be rapidly wound down. In some textbook presentations, when the federal government runs a deficit that it needs to finance with debt, the greater competition for borrowing from private capital markets leads directly to higher interest rates. In the real world of the U.
Instead, the Federal Reserve raises short-term rates when it fears that the boost to aggregate demand caused by larger deficits could stoke inflationary pressures, and this tends to put upward pressure on longer-term rates as well. This fear surfaces when the Fed thinks the economy is at full employment, i. If households tried to spend these debit cards when the economy was already at full employment, there would be no workers or equipment available to produce the extra goods and services needed to satisfy the new demand.
As the greater demand meets an unchanging supply, prices would go up, leading to inflation. If deficit-induced increases in demand threatened to push inflation too far above this target, the Fed would raise interest rates. Higher interest rates would increase the costs of goods financed with debt think autos and houses and washing machines , thereby lowering demand for these goods.
Higher rates would also make it harder for firms to borrow money to invest in tangible assets such as plants and equipment think of a restaurant owner deciding whether to take out a loan to replace the furniture in the dining room.
Finally, higher interest rates increase foreign demand for U. The resulting stronger dollar makes U. S households, which increases the trade deficit and reduces demand for U. In short, larger budget deficits run when the economy is already at full employment can threaten to crowd out investment in tangible capital by businesses and can lead to higher foreign ownership of U. This, in turn, can potentially lead to slower productivity growth as the investment slowdown deprives U.
Both of these channels can make future generations poorer than they would have been absent the increase in the deficit.
If higher rates happen without this higher inflation, this is mostly a sign that the Fed has prematurely raised rates, not a sign that deficits are obviously too large or rising too fast. The relief and recovery measures taken in response to the coronavirus shock have led to a nontrivial increase in the public debt.
In the past, a prime concern raised about higher debt was that the costs of servicing this debt paying interest on it could threaten to crowd out other useful public spending. However, this is quite unlikely to happen. However, it is beyond question that the extra growth spurred by the relief and recovery aid would boost GDP and hence tax collections enough to fully pay for the increase in debt service for the foreseeable future.
The only way this would not be true is if somehow the economy could have been relied upon to heal itself fully and quickly from the coronavirus shock without any relief and recovery. But we have run a very recent experiment with allowing the economy to try to mount a recovery from a negative demand shock without sufficiently expansionary fiscal policy.
It went badly: Recovery following the Great Recession of — was far weaker and took far longer because we shifted fiscal policy too quickly to a contractionary, rather than expansionary, stance. We should be clear that it really is this inflation barrier—whether extra increments of aggregate demand lead to more output being produced or just higher prices—that determines whether the economy is at full employment.
Often say, during wartime the economy can operate far above estimates of full employment. But for this to not lead to inflation generally requires some policy intervention like wage and price controls during World War II. It is true that the coronavirus shock also has elements of a supply-side shock. Imported inputs into manufacturing production, for example, have become scarce and expensive. Further, there are some people who could otherwise continue working but are hampered in their ability to do so because public health measures have kept children at home rather than in school or in child care settings.
Yet even the elements of this crisis that began as supply shocks e. What is the one thing I need to understand first about debt before I can gauge whether it is a threat? Why are we so sure that debt-financed relief and recovery is the answer to the economic shock of the coronavirus? Is it interest rates or inflation that rises when deficits are rising too fast? Will debt service crowd out other useful spending? OECD — Budget deficits The graph below shows that in , there was a large variance in the size of budget deficits.
There is no simple answer to whether a budget deficit is helpful or harmful because it depends on quite a few factors. It depends on when the deficit occurs. Basic Keynesian analysis suggests that a rise in the budget deficit during a recession is a good thing.
In a recession, private sector spending falls and saving rises — leading to unused resources. The deficit spending can help promote higher growth, which will enable higher tax revenues and the deficit will fall over time.
If you try to balance the budget in a recession, you can make the recession deeper. Austerity can be self-defeating. However, if the deficit occurs during a period of strong economic growth, then the government deficit will be crowding out the private sector. Government borrowing will reduce private sector investment and spending, and you could argue the government spending is more inefficient than the private sector.
One example is India. In , the Indian economy was growing quickly, but the budget deficit was 5. In this economic circumstance, India would be advised to be reducing the budget deficit. It depends on why you are borrowing. If the government borrowed to invest in improving infrastructure, it might be able to overcome market failure and improve the productive capacity of the economy. The return from public sector investment may be greater than the cost of borrowing, and so in the long-term the economy benefits from government borrowing and investment like a firm borrowing to invest in a new factory.
However, if the government borrows and mis-spends the money or spends it on transfer payment, there may be a very limited increase in productive capacity. In certain circumstances, the cost of government borrowing falls. This causes a fall in bond yields and makes the cost of borrowing lower.
In the case of the Eurozone, borrowing has been much more difficult. Bond yields have increased, despite lower budget deficits. This is because it is more difficult to borrow within the framework of a single currency. This caused bond yields to rise rapidly. Because of the nature of the Eurozone, budget deficits have become more problematic.
Eurozone economies have greater pressure to keep low budget deficits. Otherwise they are more likely to see rising bond yields. A big issue for the importance of a budget deficit, is what are the economic prospects for the economy?
If one economy is predicted to have a stagnating economy, debt to GDP is likely to continue to rise. Markets will worry about a budget deficit much more, if they feel that the economy is likely to stagnate and unable to grow.
Low growth prospects are one of the major concerns over several Eurozone economies. Yes, the budget deficit matters.
But, there is no simple answer. It is reasonable to suggest that over the course of the economic cycle, governments should seek to get close to balancing the structural deficit. However, there can be good reasons to run a deficit — at least in the short term. Also in a recession, a budget deficit can play an important role in managing aggregate demand. But, government spending financed by borrowing from the private sector can return the economy to full employment quicker.
There is no easy answer to this. There was no fiscal crisis. Very well noted salient. This is despite having previously fallen out of the trap severally. Lesson well served from this account. Readers Question: how important is the budget deficit? The government usually financed the budget deficit by selling bonds to the private sector To libertarian and free-market economists, budget deficits are liable to cause significant economic problems — crowding out of the private sector, higher interest rates, future tax rises and even potential of inflation.
Potential benefits and costs of a budget deficit Reasons to be concerned about a budget deficit Need to cut spending in the future. Higher deficits are not sustainable for ever. Reducing a budget deficit can be problematic. If a country has a deficit that increases too quickly, the government may be forced to adapt policies aimed at a sharp deficit reduction. For example, during , many countries in the Eurozone sought to reduce their budget deficit to comply with EU rules.
This deficit reduction caused lower growth, recession and unemployment. Increasing national debt. A budget deficit increases the level of public sector debt. Opportunity cost of debt interest payments. Learning alot Reply. I learned more about both budget deficit and surplus. Thanks alot Reply. We use cookies on our website to collect relevant data to enhance your visit. Our partners, such as Google use cookies for ad personalization and measurement. However, you may visit "Cookie Settings" to provide a controlled consent.
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