Debt, Deficits, and Goldilocks

December 9, 2020 by Dan Mitchell @ International Liberty 

At the risk of oversimplification and exaggeration, these six principles tell you everything you need to know about fiscal policy.

For purposes of today’s column, let’s focus on Principle #3, which is that “Deficits and debt are symptoms of the underlying problem” of excessive spending.

I’ve been making that point over and over and over and over and over again, but I feel motivated to address the issue again after reading two columns about government debt.

First, here’s some of what Paul Krugman wrote on the topic for his column in the New York Times.

…we’ve learned a lot about the economics of government debt over the past few years — enough so that Olivier Blanchard, the eminent former chief economist of the International Monetary Fund, is talking about a “shift in fiscal paradigm.” And the new paradigm suggests both that public debt isn’t a major problem and that government borrowing for the right purposes is actually the responsible thing to do. …It made some sense, nine or 10 years ago, to worry that the financial crisis in Greece was a harbinger of potential debt crises in other countries. …What briefly seemed like a spread of Greek-style problems across southern Europe turned out to be a temporary investor panic, quickly ended by a promise from the European Central Bank that it would lend money to cash-short governments if necessary. …We weren’t and aren’t anywhere close to that kind of crisis, and probably never will be. …But what about the longer term? …The important point for current discussion is that government borrowing costs are now very low and likely to stay low for a long time. …given what we’ve learned and where we are, it’s clear that the U.S. government should be investing heavily in the nation’s future, and that it’s OK, indeed desirable, to borrow the money we need to make those investments.

Second, Brian Riedl of the Manhattan Institute provides a different perspective in a column for today’s Washington Post, .

 

The election of Joe Biden to the presidency has prompted liberal calls to set aside pesky budget deficit concerns and go deeper into debt to finance large new spending initiatives… All these writers share the view that the persistence of low interest rates — currently about 1 percent for a 10-year Treasury bill — means the rules of the fiscal game have fundamentally changed. …But…deficit advocates must face two fundamental realities: First, the debt is already set to soar in the absence of any new spending. And second, these bloated debt levels will mean that any future rise in interest rates could bring a full-scale debt crisis. …Deficit doves are essentially gambling the future of the U.S. economy on the expectation that interest rates never again exceed 4 percent or 5 percent. …they are wrong to assume that state of affairs will continue. …Exceeding the projections by two or three points would mean annual interest costs consuming all projected tax revenue, leaving no taxes to finance normal federal programs. These debt spirals become nearly impossible to escape, as rising interest costs necessitate more borrowing, which in turn brings higher interest costs… Deficit doves would gamble America’s economic future on the hope that interest rates will never again top 4 or 5 percent. Are you feeling lucky?

At the risk of sounding like a muddle-headed, finger-in-the-wind moderate, I’m going to disagree with both of them (I’m like Goldilocks, who doesn’t want the porridge too hot or too cold).

I have a fundamental disagreement with Krugman because he’s overtly arguing for a bigger burden of government. Based on his past writings, he is willing to use higher taxes to finance some additional spending.

 

But the aforementioned column confirms that he’s in favor of a big amount of additional debt-financed spending as well.

He presumably wants to move the country into the lower-right quadrant of this 2×2 matrix, but doesn’t mind getting there by detouring through the lower-left quadrant.

My disagreement with Brian is probably more a matter of rhetoric. Based on his past writings, I think he wants to be in the upper-left quadrant, but he has an unfortunate tendency to fixate on the symptom of debt and deficits when he should be focusing on the underlying disease of excessive government spending.

My bottom line if that bigger government is a bad idea when it’s financed by debt, but it’s an equally bad idea if it’s financed by taxes.

Moreover, I worry when well-meaning people grouse about red ink because that creates an opening for not-so-well-meaning people to say, “I agree with you, so let’s raise taxes.”

P.S. In the real world of Washington (as opposed to blackboard theorizing), higher taxes lead to higher deficits and more debt.

P.P.S. Assuming they’re both sincere and guided by empiricism, people who care about red ink should support a spending cap.

P.P.P.S. Maintained for a sufficient period of time, spending restraint can even eliminate huge debt burdens.