Abby Phillip, a staff writer at Politico, was a guest on C-SPAN’s Washington Journal this morning to take viewers’ call-in questions and discuss the new congress’s legislative priorities. Several times during the course of her appearance, she made the statement, "The deficit is having a huge impact on our economy." Abby gave absolutely no evidence to back up this statement, expecting viewers to simply swallow this assertion whole.
Abby is not alone in simply accepting this dogma at face value. More and more congressional representatives are accepting that the deficit is negatively affecting the economy, pundits repeat it all day on television news outlets, newscasters repeat what they have heard from conservative think tanks and members of congress, newspapers print op-eds bemoaning the size of the deficit. Therefore the general public, understandably, has come to accept the statement as true.
Unfortunately, no one ever explains how the deficit is adversely affecting our economy, or even how such a statement could be true. No one ever gives any evidence of negative effects, or even where such evidence might be found. If it "sounds right," apparently no one ever feels the need to give any concrete reasons for holding such an opinion.
Jackie Calmes, in a New York Times article on January 20th, reporting on a poll showing that the public does not want to cut spending on Medicare, Social Security and education to close the deficit, simply assumes the truth of the "deficits are bad" meme and points to "accumulated debt that is starting to weigh on the economy" without giving a shred of evidence that this is true.
The time-honored way economists have of judging the effect of debt on an economy is to look at interest rates. When the bond market demands higher interest rates to service deficits and debt, the cost of borrowing the money to plug the shortfall rises. This increases the interest payments the country must pay to bondholders, which has a definite effect on the nation’s economy. But this is not happening.
Paul Krugman, Dean Baker, Brad DeLong and other real-live economists, as opposed to paid political shills, have pointed repeatedly to the low interest rates offered to the bond market and the market’s continuing purchase of bonds at these low rates without demanding an rate increase. A January 20th entry Dean Baker posted on his blog makes the point:
The current interest rate on 10-year Treasury bonds is 3.44 percent. This is far lower in both nominal and real terms than it has been (except for the last two years) for most of the last three decades.
In other words, the standard way to measure whether the debt is imposing a burden on the economy is showing clearly that it is not.
Current discussions, what there are of them, of how deficits affect the U.S. economic picture tend to revolve around a lecture we all heard in Economics 101, i.e., the hyperinflation story. This story is quite satisfying both intellectually and morally: A weak, spendthrift government can’t limit its spending to match its revenues; it loses the confidence of investors, so it has to print money to make up the difference; and too much money chasing too few goods leads to ever-higher inflation.
It’s a great story and it has the benefit of being true – sometimes. It also has the benefit of being comfortable for those who argue that government is always the problem, never the solution. Unfortunately the hyperinflation story does nothing to explain our current predicament. It is remarkable, really, the extent to which "important" people are determined to push our present economic situation into this story, even when the actual experience of the past three years doesn’t fit the story’s framework.
The reason this story doesn’t fit our present circumstances is simply because there is no evidence - zero - that investors are losing confidence in the bonds the U.S. sells to finance the deficit despite the low rates paid on the bonds, and no evidence that investors are demanding higher rates. Companies are running only about 60% of their capacity, while unemployment remains high. In order for the hyperinflation story to pertain to the U.S. economy, companies would have to start approaching full capacity evidencing the need to hire new workers, and the unemployment rate would need to decline precipitously as companies began hiring.
Krugman explains, in his usual easy-to-understand and snarky way, how these numbers shake out considering the economy’s current trajectory:
Two things are clear. First, the economy has to grow around 2 1/2 percent per year just to keep unemployment from rising. Second, growth above that level leads to a less than one-for-one fall in unemployment (because hours per worker rise, more people enter the work force, etc.). Roughly, it takes two point-years of extra growth to reduce the unemployment rate by one point.
So, suppose that US growth is accelerating. Even so, it will take years of high growth to get us back to anything resembling full employment. Put it this way: suppose that from here on out we average 4.5 percent growth, which is way above any forecast I’ve seen. Even at that rate, unemployment would be close to 8 percent at the end of 2012, and wouldn’t get below 6 percent until midway through Sarah Palin’s first term.
The main evidence the public uses to rail against deficits and the debt seems to be that deficits represent a moral problem in our economy – that the country is willing to rack up what seems like a massive debt, and it must stop because, well, it’s just not right. Wall Street bankers, hedge fund managers and conservative think-tank spokespeople are more than willing to reinforce this belief, and indeed employ scare tactics to make their point, in an effort to convince legislators to cut federal spending on the country’s largest social programs so that that spending can be redirected to the private sector.
What it all boils down to is this: As long as the bond market does not demand higher interest rates, business capacity is largely unfulfilled and unemployment remains high, neither the yearly deficit nor the long-term debt represents a problem for the U.S. economy. When the economy picks up to the point that interest rates begin to rise, companies run near capacity and enough people return to the workforce to bring the unemployment numbers down significantly, there will be plenty of time – and economic activity - to address the deficit without inflicting more pain and suffering on working class Americans.