This sounds bad, but is it? If so, why? Unemployment is low. Wages look at least okay; interest rates and inflation are low. What’s not to like, other than the historical anomaly of large deficits at low unemployment?
Our current public debt is a problem, but not in the way many critics have typically maintained. Deficits aren’t hurting the economy; in fact, if they were targeted a lot more smartly, they could help it or, more specifically, help the people and places that need the help. Instead, we’re borrowing money for all the wrong things.
The usual argument against persistent deficits, especially in good economies, is that they “crowd out” other investment. This is the idea, taught in public finance texts (see Figure 12.2 here, for example), that the government and private investors compete for a fixed lump of “loanable funds.” When the government borrows to finance its deficits, that leaves less for private borrowers, which pushes up interest rates, resulting in slower growth.
Here’s a recent warning in this spirit from the fiscal watchdog group, Committee for a Responsible Federal Budget:
“As the government issues more bonds, lenders are likely to demand higher interest rates to compete with other investment opportunities. These higher rates are likely to permeate through the rest of the economy, increasing the interest costs associated with mortgages, car loans, student loans, and credit card debt — not to mention business loans.”
It’s a logical chain, one maintained by many, including the CBO, but to say we don’t see crowd-out in the data is an understatement. Not only have large deficits coexisted with low interest rates — contrary to the theory — in recent years here in the United States, they’ve also done so in countries that make our fiscal conditions look admirable (see Greece and Japan).
Why isn’t crowd-out occurring? In the U.S. case, it’s partly the intersection of increased global capital flows (meaning more “loanable funds”) and the fact that our debt is still among the world’s safest. Then there’s the Federal Reserve, which held the benchmark interest rate they control close to zero for almost a decade after the financial crisis. Also, inflation has been so low and “well-anchored” that bond investors aren’t demanding much of a premium against the risk of higher inflation (which lowers the value of a security with fixed payouts).
So, if we don’t need to worry about crowding-out, what’s wrong with budget deficits?
I’ve got four concerns. First, while we all expect interest rates to remain low for a long while, we may all be wrong. To assign a zero probability to higher rates and thus much more expensive debt service would be reckless risk management. Second, the flip side of that “increased capital flows” argument is that more of our debt service leaks out of our economy into those of our foreign creditors (the domestic impact of deficits matters less when it’s just one group of Americans owing money to another group of Americans). Third, there’s evidence that when governments go into recessions with relatively high debt levels, they tend to do too little to offset the downturn.
Then there’s the corrupt politics of our current deficits. In case you’re not familiar with the Bernstein Rule, here it is: If you voted for the tax cuts, you can’t whine about the deficit. And yet, Republicans violate the rule whenever the CBO releases a report, going on about how these terrible, unforeseen deficits require us to cut spending on Democrats’ priorities.
Of course, this is the same crew of people who are still claiming, against all evidence, that their tax cuts will pay for themselves. In fact, careful analysis of spending and revenue patterns over the past few decades by Senate Budget Committee staffer Robert Kogan finds that had it not been for Republican tax cuts, the budget would be close to balanced.
In other words, even in the absence of crowd-out, there are reasons to be careful with deficit spending. The question then becomes: When should governments take advantage of persistently low inflation and borrowing costs and go ahead and run up deficits?
The answer calls for differentiating between good debt and bad debt. Good debt invests in productive public goods, including physical (roads, bridges, water systems) and human (job training, apprenticeships, education) capital. Good debt reduces inequality and poverty. It aggressively targets market failures, the largest of which by far is global warming.
Bad debt — of which the Trump tax cuts are exhibit A — worsens inequality, while failing to make the necessary, productive, climate-mitigating investments that are increasingly pressing.
Therefore, I’m not happy about all this red ink — even though I don’t think it’s bad in and of itself. Deficits are not always problematic, by a long shot. It’s just that our current ones have been induced by wasteful, regressive, inequality-promoting tax cuts. They’re bad debt when we need good debt.