Many developed and developing countries, confronted with the fact of finite revenues, have found it politically easier to squeeze capital rather than current spending. But from this point follows a remarkable policy conclusion that is implied but not made explicit. Yet can one seriously argue that the chief contributing factor behind higher deficits, that is, the rise in what the Office of Management and Budget calls mandatory spending things like social security and health care , and interest payments, which are now approximately two-thirds of total outlays, have actually enhanced growth?
There is one prize non sequitur in the article. Is that necessarily so bad? Eisner does not do this. Surely, the private sector is capable of saving in forms other than public debt. Since it has not been proven that government can use savings as productively as companies especially when savings merely finance higher transfer payments , the consequence of higher savings in the form of public debt and lower savings in the form of private debt is at best neutral and probably worse than that for consumer welfare.
Other adverse consequences follow, none of which Eisner mentions or deals with satisfactorily. Eventually, if the problem is not tackled in time and the debt trap finally arrives as occurred in Italy , taxes will have to be raised steeply or expenditure slashed to prevent a calamity.
Mainline economists believe that deficits, properly measured, crowd out investment, and they believe that overly large debt leads to financial fragility. To the proverbial man with a hammer, everything looks like a nail; there are so many wonderful things government might do. Eisner demonstrates scientifically that bigger adjusted deficits produce higher growth, lower unemployment, and increased investment.
And if there were any issue on how to get bigger deficits, he advocates higher public-sector spending with proven productivity performance and not the tax cuts that readily come to the minds of most Americans.
In the past 10 years, the U. Low investment reflects in good measure an overly large deficit. Moreover, if our recovery from recession is barely moving forward, at less than half the pace in the past, one reason is that the public and policymakers alike have become gun-shy over deficits, even in a recession. Our debt to GDP ratio has risen since from We are not bankrupt, whatever the Japanese might think, and, perhaps, there is even some room for complacency.
But surely this is a poor time to indulge deficit passion. When Congress votes increased structural deficits during recessions, of course, spending, output, and employment rise. And as the economy emerges from recession, investment recovers. All that says is that countercyclical fiscal policy works. This is not really red-hot news. There is an entirely separate issue, whether or not we should widen deficits every time we get a chance and never, even at high employment, return toward balanced budgets.
If our economy suffered shortage of demand endemically, we might have to worry about reducing deficits, but that is not the case. We overheat with great regularity, and that is the time when budgets should be cut. 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.
Economists and policy analysts disagree about the impact of fiscal deficits on the economy. Some, such as Nobel laureate Paul Krugman, suggest that the government does not spend enough money and that the sluggish recovery from the Great Recession of to was attributable to the reluctance of Congress to run larger deficits to boost aggregate demand. Others argue that budget deficits crowd out private borrowing, manipulate capital structures and interest rates, decrease net exports , and lead to either higher taxes, higher inflation or both.
Until the early 20th century, most economists and government advisers favored balanced budgets or budget surpluses. The Keynesian revolution and the rise of demand-driven macroeconomics made it politically feasible for governments to spend more than they brought in. Governments could borrow money and increase spending as part of a targeted fiscal policy.
Keynes rejected the idea that the economy would return to a natural state of equilibrium. Instead, he argued that once an economic downturn sets in, for whatever reason, the fear and gloom that it engenders among businesses and investors will tend to become self-fulfilling and can lead to a sustained period of depressed economic activity and unemployment.
In response to this, Keynes advocated a countercyclical fiscal policy in which, during periods of economic woe, the government should undertake deficit spending to make up for the decline in investment and boost consumer spending in order to stabilize aggregate demand. Note that a fiscal deficit is fundamentally different from a trade deficit , which occurs when a country imports relatively more value of goods than it exports abroad.
The U. Such a deficit occurs because the U. The deficit in the United States is the result of three factors. Annual military spending has doubled. Tax cuts are another cause of the burgeoning deficit because they reduce revenue for each dollar cut. While the Joint Committee on Taxation expects that the cuts should stimulate growth by 0. Lastly, Social Security is another contributor to the deficit.
According to the Henry J. The next few years should see an even larger deficit, as the global coronavirus pandemic caused a spike in unemployment and business closures, which reduces tax revenues for the government.
This package greatly increased the fiscal budget gap. These effects on the deficit are likely to be long-lasting. Even though the long-term macroeconomic impact of fiscal deficits is subject to debate, there is far less debate about certain immediate, short-term consequences. However, these consequences depend on the nature of the deficit. If the deficit arises because the government has engaged in extra spending projects —for example, infrastructure spending or grants to businesses—then those sectors chosen to receive the money receive a short-term boost in operations and profitability.
If the deficit arises because receipts to the government have fallen, either through tax cuts or a decline in business activity, then no such stimulus takes place. Whether stimulus spending is desirable is also a subject of debate, but there can be no doubt that certain sectors benefit from it in the short run.
All deficits need to be financed. This is initially done through the sale of government securities, such as Treasury bonds T-bonds. Individuals, businesses, and other governments purchase Treasury bonds and lend money to the government with the promise of future payment. The clear, initial impact of government borrowing is that it reduces the pool of available funds to be lent to or invested in other businesses.
Thus, all deficits have the effect of reducing the potential capital stock in the economy. This would differ if the Federal Reserve monetized the debt entirely; the danger would be inflation rather than capital reduction. Additionally, the sale of government securities used to finance the deficit has a direct impact on interest rates.
Government bonds are considered to be extremely safe investments, so the interest rate paid on loans to the government represent risk-free investments against which nearly all other financial instruments must compete.
This function is used by the Federal Reserve when it engages in open market operations to adjust interest rates within the confines of monetary policy. Even though deficits seem to grow with abandon and the total debt liabilities on the federal ledger have risen to astronomical proportions, there are practical, legal, theoretical and political limitations on just how far into the red the government's balance sheet can run, even if those limits aren't nearly as low as many would like.
As a practical matter, the U. Backed only by the full faith and credit of the federal government, U. The Federal Reserve also purchases bonds as part of its monetary policy procedures. Total government debt has real and negative long-term consequences. If interest payments on the debt ever become untenable through normal tax-and-borrow revenue streams, the government faces three options.
They can cut spending and sell assets to make payments, they can print money to cover the shortfall, or the country can default on loan obligations. The second of these options, an overly aggressive expansion of the money supply, could lead to high levels of inflation , effectively though inexactly capping the use of this strategy. There is any number of economists, policy analysts, bureaucrats, politicians, and commentators who support the concept of government running fiscal deficits, albeit to varying degrees and under varying circumstances.
Deficit spending is also one of the most important tools of Keynesian macroeconomics , named after British economist John Maynard Keynes, who believed that spending drove economic activity and the government could stimulate a slumping economy by running large deficits.
The first true American deficit plan was conceived and executed in by Alexander Hamilton, then Secretary of the Treasury. This practice continued, and throughout history, governments have elected to borrow funds to finance their wars when raising taxes would have been insufficient or impractical.
When the private sector employment and therefore consumption demand is shrinking, the government can increase its public sector spending by borrowing which not only increases public sector employment but also provides for safety net to unemployed benefits and helps sustain aggregate demand in the economy.
In general, government debt serves as a useful tool for conducting both monetary and fiscal policy. By allowing federal, state, and municipal governments to borrow, it lets these entities build infrastructure and create human and knowledge capital that can serve future generations. As it may not be possible for the government to fund these projects from current tax revenues, it is justified to borrow from the current generation and then pay them back by taxing future generations who are most likely to benefit from these long run projects.
Unfortunately, in the last forty years, the US government has run relatively small surpluses only during — In the rest, it has run deficits. The key issue right now is whether the present level of debt and ongoing deficits are sustainable. There is a general agreement that current benefits under Medicare and Social security programs cannot be funded from current revenue streams and as more and more baby boomers retire, these programs will eventually be bankrupt.
Either benefits under these programs need to be reduced which people on the right argue , or tax revenues need to be increased which people on the left suggest in order to meet future benefit obligations. Otherwise, the government will continue running deficits, and its debt will continue to grow, and in the end servicing and repaying this debt will itself become impossible — that is, the debt will become unsustainable.
About a third of US debt is held by foreigners and largest chunks by China and Japan.
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