How I learned to stop worrying and love the deficit

Large deficits can elicit emotional reactions (see Tea Party Movement). But Robert Frank gives some good reasons not to be too worried about our current fiscal situation:

"...when total spending falls well below the level required for full employment, the economy won’t recover quickly on its own. Consumers won’t lead the way, because even those who still have jobs are fearful they might lose them. And most businesses won’t invest, since they already have more capacity than they need. Only government, Mr. Keynes concluded, has both the motive and opportunity to increase spending significantly during deep downturns.

Of course, if the government borrows to do so, the debt must eventually be repaid (or the interest on it must be paid forever). That fact has provoked strident protests about government “bankrupting our grandchildren.” It’s an absurd complaint. Failure to stimulate the economy would mean a longer downturn. That, in turn, would mean longer stretches of reduced tax receipts, increased unemployment insurance payouts, and depressed private investment. The net result? Higher total public borrowing and a permanent decline in productivity compared with what we would have had under effective economic stimulus. Once the economy is back on its feet, deficit logic changes. At full employment, extra borrowing often compromises future prosperity, just as critics say. On President George W. Bush’s watch, for example, the national debt rose from $5 trillion to $10 trillion. Some of that borrowing paid for an expansion of prescription coverage and a financial bailout a year ago, but most went for a war in Iraq and tax cuts that largely just allowed for additional consumption. Our grandchildren will be forever poorer as a result.

But the reverse would be true if government borrowing were used for productive investments. After decades of neglect of the nation’s infrastructure, attractive public investment opportunities abound. It’s been estimated, for example, that eliminating bottlenecks on the Northeast rail corridor would generate $12 billion in benefits at a cost of only $6 billion. These are present value estimates. When government undertakes such investments, our grandchildren become richer, not poorer...

In the meantime, however, such commentary continues to render intelligent political decisions about deficits less likely. For example, 58 percent of respondents in a recent NBC News-Wall Street Journal poll said the president and Congress should worry less about bolstering the economy than keeping the deficit down, while only 35 percent said economic recovery was a higher priority. If we really want to bankrupt our grandchildren, that poll charts a promising course."

Much of Frank's argument is basic Keyensian economics: in a recession, government spending is needed to offset the decline in private spending. But whatever your feelings about Keynes' theories, Frank's basic point is quite intuitive. The vast majority of the deficit has been caused by a collapse in tax receipts, which were caused by the recession. That means that anything that will cause output to grow faster will reduce the long-term deficit by increasing tax receipts. That means that spending today won't necessarily "bankrupt our grandchildren".

The politics of deficit reduction are all too predictable: when a party is out of power, they seem to find that old religion. But that doesn't mean we can't have a rational discussion about budgets.