Return of the Great Debt Scare

Robert Reich is worried that the "Great Debt Scare" will lead to a repeat of the Clinton administration's abandonment of its investment agenda due to concerns over the deficit:

The Great Debt Scare: Why Has It Returned?, by Robert Reich: It’s the kind of thing I expect to hear from deficit hawks and chicken littles -- from the self-described "fiscally responsible" right, from the scolds Ross Perot and Pete Peterson, from my former cabinet colleague Bob Rubin. But yesterday I was shown slides developed by the putatively liberal Center for American Progress intended to make the point. And today’s front page story in the New York Times, by the eminent David Leonhardt, entitled "Sea of Red Ink: How It Spread From A Puddle," puts the issue right before our progressive noses, so to speak.

The Great Debt Scare is back.

Odd that it would return right now, when the economy is still mired in the worst depression since the Great one. ...

Odder still that the Debt Scare returns at the precise moment that bills are emerging from Congress on universal health care, which, by almost everyone’s reckoning, will not increase the long-term debt one bit because universal health care has to be paid for in the budget. In fact, universal health care will reduce the deficit and cumulative debt -- especially if it includes a public option capable of negotiating lower costs from drug makers, doctors, and insurers, and thereby reducing the future costs of Medicare and Medicaid.

Even odder that the Debt Scare rears its frightening head just as the President’s stimulus is moving into high gear with more spending on infrastructure. Every expert who has looked closely at the nation’s crumbling infrastructure knows how badly it suffers from decades of deferred maintenance... These public investments are as important to the nation’s future as are private investments.

First, some background: Deficit and debt numbers ... take on meaning only in relation to ... the size of the national economy..., in particular, to the debt/GDP ratio. True, that ratio is heading in the wrong direction right now. It may reach 70 percent by the end of 2010. That’s high, but it’s not high compared to the 120 percent it was in 1946, after the ravages of Depression and war.

Over time, the basic way America has reduced the debt/GDP ratio is by growing the U.S. economy. GDP growth makes even large debts manageable. When the economy is cooking, more people have jobs and better wages. So they pay more taxes. And they require less unemployment assistance and other social insurance. That’s why it’s so important now, in the depths of depression, that government, as purchaser of last resort, steps in and runs large deficits. Without large deficits this year and next, and perhaps the year after, the economy doesn’t have a prayer of getting back on a growth path, and the debt/GDP ratio could really get ugly. ...

In this respect, national budgets are like family budgets. It’s dumb for an indebted family to borrow more money to take a world cruise. But it’s smart even for an indebted family to borrow money to send their kids to college. So too with the Obama budget. Public investments, just like family investments, build future wealth. They allow faster growth. They make the debt/GDP ratio even lower and more manageable over time.

Don't get me wrong. I'm not saying there's nothing to worry about when it comes to long-term deficit and debt projections. I'm just saying now's not the time to worry, and we ought to temper our worries by understanding the larger context.

Not every expert agrees that a deficit-driven stimulus is the best and fastest way to get the economy back on a growth track, or that public investments can speed growth. Conservative economists, Republicans, and many Wall Streeters are skeptical because they don’t think government can do anything well. But look at the record of the last seventy-five years -- look at how the nation got out of the Great Depression, and consider the critical role public investments have played since then in speeding the nation’s growth, investments such as the interstate highway system -- and you have ample evidence that the deficit hawks are wrong. They were wrong when they convinced Bill Clinton to chuck a large part of his investment agenda (the nation is now paying the price) and they're wrong now.

So, back to the mystery. Why are the ostensibly liberal Center for American Progress and New York Times participating in the Debt Scare right now? Is it possible that among the President’s top economic advisors and top ranking members of the Fed are people who agree ... with conservative Republicans...? Is it conceivable that they are quietly encouraging the Debt Scare even in traditionally liberal precincts, in order to reduce support in the Democratic base for what Obama wants to accomplish? Hmmm.

Not so sure about that, but the larger point is certainly valid. The economy needs short-term demand stimulus, and that stimulus can be from spending on infrastructure, or it could be on something with little long-run benefit such as large firework shows held throughout the nation - big extravagant events that spend millions and millions of dollars in the most depressed economic areas. In the short-run the goal is to kick start the economy, and a firework show is just as good at that task as infrastructure spending if the spending is approximately the same.

Where they differ is in the long-run. The firework show leaves only memories - and sometimes that's enough to justify an expenditure - but let's assume that for the most part the shows were nothing more than an excuse to spend money to get the local economies moving (not that there's anything wrong with that; also, perhaps a series of shows would be better so that the impulse is spread out over time and sustains the economy through the downturn, but the idea is the same). However, as Robert Reich explains above in his example of borrowing to go on a cruise versus borrowing to go to college, infrastructure spending does have long-run benefits and can help the economy grow faster.

So, to the extent that we can, we should do both - deficit spend to get the economy moving in the short-run, and spend the money on infrastructure so the spending has long-run benefits. But the main thing is to get the economy moving again through deficit spending, it doesn't have to be on infrastructure (and there are plenty of things to spend the money on in the short-run that don't necessarily help with long-run growth but are nevertheless justified, there are choices other than firework shows and cruises, but the politics work against this).

So deficit spend in the short-run and target infrastructure as much as possible - until further spending on infrastructure begins to threaten short-run goals because, for example, it can't be done fast enough - then switch to other types of spending to give aggregate demand the kick it needs.

It may seem like I disagree with Robert Reich in that he is insisting that the spending be to rebuild our physical and social infrastructure, where I am saying it doesn't matter, but that's because we need to separate two reasons for deficit spending. What I have just described is deficit spending to offset cyclical swings in the economy, so called countercyclical policy. What Robert Reich describes in his example with the family is spending that is an investment in the future. You borrow money now in the hopes of a higher return in the future (in terms of economic growth), a return that is high enough to justify the costs. Note that this type of spending is entirely justified independently of spending to offset recessionary conditions. However, because of the politics involved, and because it can be efficient in any case, combing the two types of spending - i.e. using infrastructure spending to stimulate the economy - has benefits.

But although right now deficit spending is justified by countercyclical policy and by the need for social and physical infrastructure, we also need a plan for the long-run that credibly manages the resulting debt. Not immediately, but slowly over a long period of time. Importantly, however, that plan should not threaten or compromise our ability to do what's needed to offset the effects of this recession. I wouldn't mind having the conversation about managing the long-run debt now if it didn't do exactly that, i.e. cause policymakers to be wary of deficit spending and do less than is needed to combat the recession. But it does, and as Robert Reich notes, that is likely the point of the conversation.

I want both monetary and fiscal policy to have the best possible chance for success in dealing with our present difficulties, and that requires a large sustained shock to the system both in term of Fed actions and deficit spending. But success also requires managing the long-run appropriately. When things improve we have to pay for the stimulus to the economy (i.e. pay for all of the countercyclical part plus our share of the investment in infrastructure) and take the steps necessary to bring the budget into long-run alignment. If we don't do that, the conclusion will be that we can deficit spend when times are bad without any problem, and sure, that is helpful, but we simply do not have the discipline to pay for what we borrowed when times are better. Our inability to implement countercyclical policy effectively could then mean that future generations would not have countercyclical fiscal policy at their disposal when they need it.

But for now the main thing to realize is that "This thing ain’t over yet," and we need to continue to support aggressive policy action. We do have work to do to get the long-run budget fixed, and working on health care is a large step in that direction, but for now short-run policy goals must come first.

Comments

[Jasper M:]

" The economy needs short-term demand stimulus"
Oh, goodness! It 'needs' nothing of the kind! In fact, temporary interventions can reasonably be expected to have minimal impact, as rational actors will factor in their expiration.

People who can add (including some new converts) are bringing up the debt because it is suddenly growing even faster than it had been, while receipts are foredommed to shrink drastically.

And it doesn't help that the Chinese are clearing their throats.

I am not surprised the Robert "Third" Reich is not numbered among the concerned - I believe the man never saw a government expansion he didn't like. I wonder how he would weigh the benefits of "contracyclical fiscal policy" (= money [mis-]allocated by non-market means, thus mostly wasted), vs. the open ended costs of a debased currency, and an inability to borrow at endurable rates?

"Our inability to implement countercyclical policy effectively could then mean that future generations would not have countercyclical fiscal policy at their disposal when they need it."
Come to think of it, I distinctly remember hearing something very like that, when president Carter was diselected - Big government Democrats were bemoaning that "We were just getting control of the business cycle!"

These theories proceed from pure sophistry. It is a sign of the bad effect this Administration is already having on the nation's intellectual life that the likes of Robert "Third" Reich feel are crawling back out from under their rocks.

Jun 12 03:35 AM

[Valley Boy:]

I was listening to Robert Reich on the radio sometime early this year
during an interview with the radio station's reporters. He was asked
how would we pay for the then-proposed stimulus package and why
would we think we could afford it. He answered that there are these pools of foreign money because foreigners are interested in investing with us. I thought to myself: "Yeah, sure."

Jun 12 02:31 PM

[joebhed:]

While it's nice to see the prObama dialogue, most readers would see good reason for the Great Debt Scare. It's scary.
There's only been one point in history during which our debt-load looked anything like what it is today, in real terms.
That was during WW II.
How anyone can compare 2009 America to 1946 America is just beyond me.

But, most importantly, both Volcker and Taleb now agree that the amount of unpayable debt-service is what is wrong with the financial-economic system.

www.huffingtonpost.com...

We do not have the money - it does not EXIST - to make the debt-service payments on all the DEBT-money already out there.
Moreover, ALL new money is created as a debt.
So, we need to reduce the amount of debt out there, or else the walls come tumbling down.
See "How Debt Money Goes Broke".

www.financialsense.com...

It would be really nice if a nice young black man from Chicago would put his big ears to the ground; he might hear that campaign that was presented to FDR's cabinet by the original Chicago school progressives -
The Chicago Plan for Monetary Reform.

You see, the problem is that the money interests controls the bizschools to the point that their one curricula is the reason why Bush's guys are Obama's guys.

What we need is progressive monetary reform.
And I do not mean Glass-Steagall.

Jun 12 04:30 PM

[Bjarne Jensen:]

Deficit spending is counterproductive when the velocity of money is less than 1!!!!

Jun 12 07:01 PM

[snagglesnarf:]

Blah blah blah, if you keep spending far more money than you take in then you'll eventually go bankrupt. And our creditors won't give a damn what we spent the money on.

Jun 12 10:46 PM

[CLH:]

Mark you write garbage. To double and triple our health care costs by having the govt. run it is senseless. It has failed in both Europe and Canada.

Jun 13 07:33 AM