Deficits matter again
Not long ago prominent Republicans such as Paul Ryan, the speaker of the House, liked to warn in apocalyptic terms about the dangers of budget deficits, declaring a Greek-style crisis was just around the corner. But now, suddenly, those very same politicians are perfectly happy with the prospect of deficits swollen by tax cuts; the budget resolution they’re considering would, according to their own estimates, add $9 trillion in debt during the next decade. Hey, no problem.
This sudden turnaround comes as a huge shock to absolutely nobody — at least nobody with any sense. All that posturing about the deficit was obvious flimflam, with the purpose of hobbling a Democratic president, and it was completely predictable that the pretense of being fiscally responsible would be dropped as soon as the GOP regained the White House.
What wasn’t quite so predictable, however, was that Republicans would stop pretending to care about deficits at almost precisely the moment deficits were starting to matter again.
Those apocalyptic warnings are still foolish: America, which borrows in its own currency and therefore can’t run out of cash, isn’t at all like Greece. But running big deficits is no longer harmless, let alone desirable.
The way it was: Eight years ago, with the economy in free fall, I wrote that we had entered an era of “depression economics,” in which the usual rules of economic policy no longer applied, in which virtue was vice and prudence was folly. In particular, deficit spending was essential to support the economy, and attempts to balance the budget would be destructive.
This diagnosis — shared by most professional economists — didn’t come out of thin air; it was based on well-established macroeconomic principles. Furthermore, the predictions that came out of those principles held up very well. In the depressed economy that prevailed for years after the financial crisis, government borrowing didn’t drive up interest rates, money creation by the Fed didn’t cause inflation and nations that tried to slash budget deficits experienced severe recessions.
But these predictions were always conditional, applying only to an economy far from full employment. That was the kind of economy President Barack Obama inherited; but the Trump-Putin administration will, instead, come into power at a time when full employment has been more or less restored.
How do we know we’re close to full employment? The low official unemployment rate is just one indicator. What I find more compelling are two facts: Wages are finally rising reasonably fast, showing that workers have bargaining power again, and the rate at which workers are quitting their jobs, an indication of how confident they are of finding new jobs, is back to pre-crisis levels.
What changes once we’re close to full employment? Basically, government borrowing once again competes with the private sector for a limited amount of money. This means deficit spending no longer provides much if any economic boost because it drives up interest rates and “crowds out” private investment.
Now, government borrowing can still be justified if it serves an important purpose: Interest rates remain very low, and borrowing at those low rates to invest in much-needed infrastructure is still a very good idea because it would raise productivity and it would provide a bit of insurance against future downturns.
But while candidate Trump talked about increasing public investment, there’s no sign at all congressional Republicans are going to make such investment a priority.
No, they’re going to blow up the deficit mainly by cutting taxes on the wealthy. And that won’t do anything significant to boost the economy or create jobs. In fact, by crowding out investment it will somewhat reduce long-term economic growth. Meanwhile, it will make the rich richer, even as cuts in social spending make the poor poorer and undermine security for the middle class.
But that, of course, is the intention.
Again, none of this implies an economic catastrophe. If such a catastrophe does come, it will be thanks to other policies, such as a rollback of financial regulation, or from outside events such as a crisis in China or Europe. And because stuff does happen, and a lot depends on how the U.S. government responds when it does, we should be concerned that the incoming administration only seems to take economic advice from people who have been consistently wrong about, well, everything.
But back to deficits: the crucial point is not that Republicans were hypocritical. It is, instead, that their hypocrisy made us poorer. They screamed about the evils of debt at a time when bigger deficits would have done a lot of good, and are about to blow up deficits at a time when they will do harm.