Does growing federal budget deficit matter?

In a Q&A column this summer, I wrote about the nation’s ballooning debt and deficit. Many of you followed up and wanted a deeper dive about federal borrowing, so here goes.

To calculate the deficit, take the nation’s revenue (the amount of money that the government takes in), and subtract the amount of money that the government spends.

For fiscal year 2020, the Congressional Budget Office (CBO) projects a federal budget deficit of $3.3 trillion in 2020 ($3.3 trillion in revenue and $6.6 trillion in spending), which, according to CBO, “is more than triple the shortfall recorded in 2019, mostly because of the economic disruption caused by the 2020 coronavirus pandemic and the enactment of legislation in response.”

Deficits (and their rarer siblings, surpluses) are calculated on an annual basis. The federal debt held by the public is the amount a country must borrow to fund its annual deficit. CBO notes that next year will be a milestone, and not a good one. In 2021, the U.S. debt will grow larger than the total economy for the first time since 1946, right after the government financed World War II. The calculation, known as debtto-Gross Domestic Product (GDP), is a way to make sense of these huge numbers.

Debt-to-GDP was already getting pretty big last year, increasing to 79%, primarily due to the 2017 tax cuts. But the pandemic recession, along with all of the spending associated with keeping the country afloat, has increased that share to 98% for fiscal 2020, which concludes in September. It is expected to surpass 100% in 2021 and increase to 107% in 2023, which would be the highest in the nation’s history.

For years, economists have warned that deficits are necessary in extreme times — and a global health pandemic certainly qualifies. But many of you asked what’s the problem with persistent, large deficits? The traditional answer is that as the government is forced to borrow more money, interests rates rise, and those rising rates “crowd out” investment in the private sector. Here’s a simple way of thinking about crowding out: If the government has to pay higher interest rates on its debt, then investors would likely lend money to the government, rather than the private sector, because it would be seen as a safer alternative. If the private sector can’t access financing, then growth and productivity would be lower, reducing future economic growth.

Just in time for historic deficits is a new book by economist Stephanie Kelton, “The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy.” Last year, I moderated a debate between Kelton and Marci Rosell, the former chief economist for CNBC, during which Kelton laid out the thesis for Modern Monetary Theory (M.M.T.): Budget deficits are not three-alarm fires for those governments with their own currency (like the U.S.), as long as there is full employment and until those imbalances create inflation. When inflation becomes a problem, federal legislators would step in and provide economic stabilizers.

Rosell countered by saying that M.M.T. is a “beautiful theory,” but the devil is in the details and she does not believe that we could rely on fiscal policy (meaning Congressional action) to come to the rescue.

The pandemic response may illustrate both of their cases. Early on, Congress acted and spent $2.2 trillion to spur the economy, while recently, lawmakers remain stalemated on new stimulus. M.M.T. may not be the answer, but given that the Federal Reserve is likely to keep interest rates at zero for a long time, the U.S. could be conducting a real-time, long-term experiment on the impact of debt and deficits on economic growth.