Consensus Builds on Deficit Spending

In the final presidential debate last week, moderator Bob Schieffer asked two questions on our nation's fiscal position. The first question, one that's been asked in various forms at the earlier two debates, challenged the candidates to identify which of their proposed programs they'd have to cut in the face of a growing deficit. The second asked the candidates if they thought they could balance the budget in four years.  There followed some warbled discussion -- U.S. Sen. Barack Obama said he supported the "pay-go" approach to spending, then detailed the sorts of investments in science, energy, and education we needed to make. U.S. Sen. John McCain said he would take a hatchet, then a scalpel, to the federal budget, and said, "Sure I do," when asked if he thinks he can balance the budget.

These debate questions and ensuing discussion were most likely a nod to Americans' growing economic anxieties. To many Americans, “balancing the budget” seems like a responsible, prudent goal in the aftermath of excessive war spending, a “drunk” Wall St., and expensive bailout package. But history suggests otherwise – recall the New Deal and FDR’s agenda of massive government spending. Or think about what constitutes GDP: consumption + government spending + investment + net exports. And so it was on Friday, the day after the debate, that Nobel economist Paul Krugman advocated increased government spending in his New York Times op-ed:

It’s politically fashionable to rant against government spending and demand fiscal responsibility. But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold. 

What we need right now is more government spending — but when Mr. McCain was asked in one of the debates how he would deal with the economic crisis, he answered: “Well, the first thing we have to do is get spending under control.

Today, the New York Times sounded the same refrain in a front page article on the growing consensus to let the deficit grow:

... extra spending, a sore point in normal times, has been widely accepted on both sides of the political aisle as necessary to salvage the banking system and avert another Great Depression.

“Right now would not be the time to balance the budget,” said Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a bipartisan Washington group that normally pushes the opposite message.

Confronted with a hugely expensive economic crisis, Democratic and Republican lawmakers alike have elected to pay the bill mainly by borrowing money rather than cutting spending or raising taxes.

This piece is a good read in that it goes into the short- and long-term inplications of letting the deficit grow. For instance, foreign lenders are currently accepting interest rates of 4 percent of less to buy U.S. debt in the form of Treasury securities. This means that the United States will owe $40 billion for every $1 trillion it borrows.  Relative to the size of our economy - $14 trillion – this is a modest sum. So financing our deficit right now is relatively inexpensive. As the economy recovers, however, interest rates will likely go up, increasing the cost of our debt. But our accumulated debt will shrink in relation to the national income available to pay off our debt.  This leaves one to believe that deficits are sustainable over the long-term. That said, our financial system is a mess and the depth of the recession is still unknown – the basic assumptions that our economy can withstand deep deficits are being tested, and calls for balancing the budget are likely to return as the deficit grows.