The Washington PostDemocracy Dies in Darkness

These economists say a $1 trillion deficit is just a good start

What's a "deficit owl" and why do they make people so mad? (iStock)

Members of both parties are rushing to again sound the alarm about America’s rising deficit, warning of its potentially disastrous impact on the nation’s ­financial health.

This month, the Congressional Budget Office estimated that the government’s annual deficit would top $1 trillion by 2020, triggering another round of hand-wringing over the budget gap by Republicans, Democrats, tea party­ers and think tanks of all stripes.
But what if they’re all wrong?

That’s the view of a small group of heterodox economists — self-described the “deficit owls” — who say that the deficit does not pose a problem, and that the proposals to rein in the deficit represent the real threat to the nation’s well- being. Deficit spending, they say, has given the government extra money to fund social services, stimulate the economy, and react to natural disasters. And all the dire warnings of a coming crisis, they say, are, at best, well-intended alarmism — and, at worst, a sneak attack on welfare, Medicare and other progressive priorities.

“Most of the deficit hysteria is political,” said L. Randall Wray, a senior scholar at the Levy Economics Institute at Bard College. “It’s not about economics. The economy is in no danger whatsoever in the foreseeable future of overheating, which is the only time extra deficit spending could be a problem.”

Deficit hawks agree that it’s hard to know when a deficit crisis will occur, but they argue that the consequences are so drastic that even the possibility can’t be on the table. They accuse the owls of playing a dangerous game of debt brinkmanship.

“It’s an unlikely scenario that becomes more likely the bigger and the faster-growing our debt it. But these economists don’t ­really address that risk: They just say it wouldn’t happen, which isn’t very reassuring,” said Marc Goldwein of the Committee for a Responsible Federal Budget.

This view is supported by Washington’s most prominent think tanks, with some even giving awards for fiscal hawkishness, and widely accepted by much of Congress.

Deficit hawks have a list of threats posed by growing U.S. debt, but the owls have their own answer to each one.

1. "If the debt gets too big, creditors will either stop lending to us or start charging tons in interest"

Like several others before it, the CBO’s most recent report warns that current deficit levels make it more likely that America will face a “fiscal crisis,” in which private investors refuse to finance government borrowing — or at least refuse to lend the government money at low interest rates.

A sudden cutoff from creditors, deficit hawks say, would be the nightmare scenario for the country, with the government failing to pay its bills and undermining trust in U.S. government debt — a pillar of the global financial system. Without willing lenders, the nation would undergo a rapid round of forced austerity, with sharp cuts to social programs hitting at the same time as a severe recession.

Though other countries have faced such a scenario — most notably Argentina in 2001 and Greece after the Great Recession — the deficit owls say this kind of cataclysm almost certainly cannot happen here. Unlike many other countries, America prints and borrows in its own currency. When the Treasury Department needs more money to pay its debts, it issues and sells bonds that can be bought on the open market to fund its obligations.

“Federal dollars are something we invent,” said John Harvey, professor of economics at Texas Christian University. “Default is completely and totally off the ­table. The government can’t possibly go bankrupt in its own currency.”

But even if default is off the table, some hawks fear lenders will see massive deficits and start worrying that the government won’t pay its debts. That could lead to them demanding higher interest rates and set off a perilous cycle of growing debt and higher rates.

In the view of the owls, before interest rates climbed, the Federal Reserve would step in to hold them down. The Fed sets the range for the rate at which banks borrow money from each other overnight — the “federal funds rate.” The owls say other interest rates, especially on short-term government debt, tend to closely follow this number.

And while the Fed is independent of the rest of the federal government, the owls say that if the country faced a financial catastrophe, its central bank would step in. “The Fed is the market maker,” said Pavlina R. Tcherneva, an economist at Bard College. “If the Treasury wants to sell bonds, the Fed will do everything possible to make sure it can.”

The deficit owls also note that Japan has run extremely high deficits for several years recently without triggering high interest rates. Japan’s national public debt surpasses one quadrillion yen (a trillion with three zeros tacked on), or 230 times its gross domestic product. Yet Japanese interest rates have barely budged.

2. "Deficit spending could drive out-of-control inflation."

Deficit spending pumps dollars into the economy, and if those dollars aren’t accompanied by more goods and services consumers can buy with them, then prices rise — inflation that can slow economic growth and hurt anyone who is on a fixed income or whose pay doesn’t keep pace with rising prices. Indeed, former senator Judd Gregg (R-N.H.), co-chair of the advocacy group Fix the Debt, says that’s exactly what’s happening now, with the deficit putting America on the path to an “inflationary event.”

The deficit owls do not dispute that higher deficit spending by the government could, under certain circumstances, prompt inflation. But under the current economic conditions, they don’t think it will. An economy where higher deficits could cause runaway inflation, they say, would also be one in which there’s no “slack” left — where more spending can spur only greater competition for existing goods and services (hence inflation), rather than growth that creates more goods and services to buy.

“What [the hawks are] saying is that the economy is at full employment and we can’t expand any further, when we have pretty good evidence that there is quite a bit of slack in the economy,” ­Tcherneva said, noting stubbornly slow growth in wages and high percentages of Americans who remain out of work, though they are not included in the calculation of the official unemployment rate. (The most widely used unemployment rate, currently a low 4.1 percent, counts people who are out of work but seeking a job, but it doesn’t account for people who have given up looking.)

Instead, some of the deficit owls believe that we may have too little inflation right now, in part because it would suggest higher growth. Inflation rates have stayed around or below 2 percent since the Great Recession. “After the massive deficit spending associated with [President Obama’s] stimulus and all the warnings of hyperinflation, inflation averaged less than 1.5 percent,” TCU’s Harvey wrote in an email. “Indeed, last month, prices actually fell.”

3. "Money we spend paying down the debt is money we can't spend anywhere else." 

The government is expected to spend $263 billion in 2017 on debt interest payments, and that's projected to jump to $316 billion in 2018. To deficit hawks, that's money that could be spent elsewhere: better schools, health care, military funding, or a even a rainy day fund for the next recession.

But since the deficit owls do not believe the government can run out of money, they say there’s no reason to believe these payments are coming at the expense of anything else.

“We’re all taught that there’s a hard and binding financial constraint on spending, but it’s a relic of the gold standard era — there’s a notion we’ll run out of gold coins. But this is a sovereign monetary system,” where the amount of currency is determined by the state, Tcherneva said. “It’s not a trade-off because you can create as many dollars as is necessary to either pay off interest or build bridges.”

Other economists disagree, because they see deficit spending limited by the government’s unwillingness to trigger a financial panic with higher debt.

4. "High levels of government debt crowd out private investment and hurt the economy." 

The CBO and some economists have warned that higher levels of government debt will “crowd out” private investment, by putting more of the money in the economy in the public sector. “When the government borrows, it borrows from households and businesses whose saving√ would otherwise be financing private investment,” the CBO said in its most recent report.

The deficit owls say the government borrowing comes out of a different pool of potential investment than businesses dip into. The deficit hawks believe in what the owls derisively refer to as the “loanable funds market” theory — the idea that there’s a fix pool of investment that can be swallowed up by government deficit financing. But the deficit owls say that bigger government deficits increase the available capital in the private sector by pushing bonds — a kind of asset — into the market.

“When they spend more than they take in they create ‘crowding in,’ putting more money in the private sector,” said Stephanie Kelton, an economist at Stony Brook University and a former adviser to Sen. Bernie Sanders (I-Vt.). “This money ends up somewhere.”

5. So when are deficits bad?  

To be clear, the deficit owls acknowledge deficits can pose a serious threat to economic health, particularly by driving up inflation.

Mainstream economists, including those of the center-left, hold that the federal government should run deficits when the economy falls into a recession, as government spending compensates for the fall in private sector spending. (This was the justification used under President Obama to ramp up spending during the Great Recession.) Similarly, traditional economists often believe that the government should pay off their deficits and run surpluses when the economy is growing, to prepare for a downtown.

But the deficit owls don't agree that deficit spending should be limited to recessions. They say running government surpluses will contract private sector spending (a position contested by other economists), and that doing so risks slowing down an economy for no clear reason. "It's completely fallacious to argue that balance in the budget is some normal state," said James K. Galbraith, a deficit owl and economics professor at the University of Texas at Austin.

Tcherneva, the economist at Bard, suggests imagining an entire economy that consists of one tree that can only produce five oranges. If the government creates deficits simply to outbid everyone else for an orange, then it would only make the supply of oranges more expensive. That would be an example of ill-advised government spending.

"If you can keep spending and your unemployment rate can keep declining and labor force participation rate keeps improving, then you're not at your resource limit," Tcherneva said.

6. What if deficits are good? 

To the deficit owls, America’s red ink enables a great deal of good. For one, by allowing the government to spend at current levels, deficits avert cuts to social welfare programs that Americans rely on to access health insurance or receive pensions in their old age. The owls see deficit concerns as serving as a smokescreen for those aiming to cut Social Security and Medicare. “The hawks are circling above the Social Security Administration,” said James K. Galbraith, a deficit owl who is an economics professor at the University of Texas at Austin.

Deficits can be expanded as long as they can continue to reduce unemployment, bring more people into the labor market, and improve economic health in poor parts of the country, Tcherneva said. Galbraith argued that the nation can still afford big investments in long-term capital improvements and infrastructure projects.

“It’s what a credit economy is for: You borrow in order to build things,” Galbraith said. “And there’s no evidence there would be risk associated with this.”