## Wednesday, June 10, 2009

### We've been spending for a long time

David Leonhardt has a great piece in today's Times about where our tremendous deficit came from (here's the article and here's the accompanying Economix post). As he shows, the $1.22 trillion deficit for 2009 has many components: "...we were [sic] able to construct a time series, showing how budget estimates for 2009-12 have changed over time. Because the C.B.O. attributes the changes in its estimates to specific causes — namely, changes in the economy and new legislation — we were then able to create four different categories to explain how the$846 billion annual surpluses that were forecast in 2001 for 2009-12 have turned into \$1.22 trillion annual estimated deficits. Those four categories are: economic changes, which I refer to as the business cycle in my column; Bush administration legislation; Bush-era policies that are scheduled to expire but that Mr. Obama is extending; and new Obama administration policies."
While many are apoplectic about our current fiscal situation, it's important to distinguish between long-term and short-term deficits. Many, if not most, economists agree that it's a good idea to run short-term deficits during recessions. These deficits stem from a decline in tax revenue and from expansionary policy (eg the stimulus). Amazingly, the stimulus plan accounts for only 7% of our current deficit.

On the other hand, longer term deficit policies are a bigger concern. While the economy will recover and the stimulus will expire, spending on upper-income tax cuts (if made permanent) and long-horizon wars may haunt the government for years to come.

Governments run deficits all the time, so why worry now? The chief concern is that our creditors (countries like China and other foreign investors) may come to question our ability or willingness to pay them back. This could lead to sharply increased interest rates (which will hamper the economy) or necessitate the Fed to print money (which will cause a significant rise in inflation). UC Berkeley economist Alan Auerbach cites recent increases in interest rates on 5-year Treasury bills (a sign that investors worry about getting their money back) as evidence that this is already starting.

Like most American's, the US government will have to start tightening its belt sooner or later. What spending gets cut will likely be contentious. Some spending, such as universal healthcare, may be popular enough to maintain traction. Others, like extending the Bush tax cuts or some proposed Obama programs may not. It will be interesting to see our political system if it finally acknowledges we can't have it all.