By Simon Johnson and James Kwak
Tuesday, October 13, 2009 12:06 AM
The editorial page of this newspaper on Sunday came out against using additional fiscal stimulus to boost national output and reduce the growth rate of unemployment. The basic argument, made in qualitative terms, was that the costs of the incremental national debt would outweigh the benefits in additional output and well-being for the people benefited.
The national debt may be a hammer, but not everything is a nail.
Ever since the early Clinton administration, the sophisticated, hard-headed thing has been to say that deficits matter. Bill Clinton and Robert Rubin made the case that if you care about national prosperity and social welfare, you have to balance the budget, which has the effect of reducing interest rates. Traditional liberals who wanted only to increase spending on social programs were branded as "soft." (Of course, later we had an administration that increased spending while cutting taxes, adding $6 trillion to the cumulative deficit over the next 10 years, but it established its credibility for toughness by invading Iraq.)
Today, we face the largest federal government deficits since World War II and our fiscal position is likely to only get worse as the population ages, Social Security and Medicare expenditures increase, and our creaky pension system springs more leaks. The government also took on massive potential liabilities bailing out the financial system over the past year, which could increase the risk of inflation in the long term. The recession, which was severely deepened by the financial crisis, has also caused a steep drop in tax revenue, further increasing the national debt.
This means that we need to fix our health-care system, and that we cannot afford another financial crisis on the scale of the last one. But it has little to do with the policy question on the table: whether to spend more money to cushion the impact of the recession on the national economy and on the people suffering from it.
The textbook argument for fiscal stimulus still applies. We face a large output gap -- the difference between the amount the economy could produce and the amount it is producing -- because demand from households (for consumption) and companies (for investment) is low. The government should therefore increase spending in order to increase demand and help close the output gap. This should be balanced by lower spending or higher taxes when the economy has recovered. The fact that our baseline amount of debt has changed does not affect the validity of this principle.
The cost of additional stimulus, according to The Post's editorial, is "a higher national debt burden, which future Americans must pay off by working harder and saving more than they otherwise would have." But the idea that we are borrowing from our grandchildren is a common fallacy. As Mark Thoma pointed out in an example that is worth reading, issuing debt today is a transfer of cash from someone with savings to all the people who benefit from whatever the government spends the proceeds on; when the debt comes due -- in, say, 30 years -- there will be a transfer of cash from taxpayers to whoever is holding the bond at that point. (For example, the heirs of the person who bought the bond.) The money doesn't move from one generation to another.
But what about China? Aren't we borrowing money from China? Yes, but at the margin, we as a country (combining households, businesses and the government) are getting the money at a very low interest rate that we don't have to pay back for a long time. Now, this probably cannot go on forever -- that interest rate could start to rise -- but as Dean Baker points out, the underlying problem is that we export less than we import, which is what causes foreigners to accumulate financial claims on us.
The proper questions to ask, as with all borrowing, are whether the money is being used for a worthwhile purpose and whether it will push up the interest rate at which we borrow. Even though we have the luxury of borrowing money in our own currency, which we can always print more of, at some point lenders will get leery of that prospect and start demanding higher interest rates. But is now the right time to worry about that, with the yield on 10-year Treasurys around 3.4%? At this point, it is likely that risks of higher future interest rates are driven more by the expansion of the Federal Reserve's balance sheet in the wake of the financial crisis than by fiscal policy.
Whether the money will be used effectively is a better question, especially when Congress is involved. But just as in the original stimulus debate early this year, there are some obvious places to start, such as extending unemployment benefits and providing direct aid to states. Extended unemployment benefits are occasionally criticized (generally by people who have never been on unemployment benefits and don't realize how paltry they are in this country) as reducing the incentive to work. But as Planet Money pointed out a few days ago, there are six unemployed people for every current job opening.
As for state finances, the Center for Budget and Policy Priorities projects that aggregate budget shortfalls will grow from $110 billion in the 2009 fiscal year (ended June 30 for most states) to $168 billion in 2010 and to $180 billion in 2011. Because states do not have the country's nearly unlimited ability to raise money by issuing debt, those shortfalls translate into more job cuts and fewer services.
We are not saying that we should simply ignore the national debt. But the best way to address the debt is to make a binding commitment now to raise taxes in the future when the economy recovers. The second-best way is to pass health-care reform that has a reasonable chance at reducing the growth rate of health costs. And the third-best way is to reform the financial system to minimize the chances of and the potential damage caused by another financial crisis. Using the national-debt bogeyman to avoid taking obvious steps to combat the recession and helping its victims is misplaced tough-mindedness.