How America Learned to Stop Worrying and Love Deficits and Debt

The old rules are being rejected, among liberals and conservatives, politicians and economists.

CreditNicolás Ortega

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CreditCreditNicolás Ortega

By Neil Irwin

• Feb. 23, 2019

Here are three things that have happened so far in 2019.

• The former chief economist of the International Monetary Fund, Olivier Blanchard, argued in a speech that for countries like the United States, high public debt isn’t necessarily a problem. To people who follow the I.M.F., it was as if a former pope came out with an endorsement of the devil.

• Alexandria Ocasio-Cortez, the charismatic new congresswoman who has shown an uncanny ability to drive public policy debates, indicated openness to “modern monetary theory,” the idea that public spending need not be constrained by tax revenues.

• President Trump delivered an 82-minute-long State of the Union speech in which he did not use the words “debt” or “budget deficit.”

Economic orthodoxy that ruled for decades held that fiscal responsibility was inherently good and the national debt a leviathan to fear. Now the intellectual and political currents are flowing — gushing, really — in the opposite direction.

After President Trump’s election, Republicans decided to pursue their agenda of tax cuts and higher military spending without doing the unpopular work of paying for it.

Democrats are coming to believe they have hamstrung themselves in pursuit of their goals by worrying about so-called pay-fors, policies that offset the cost. When they next take power, they may feel empowered to take on a much more ambitious, expensive agenda.

And macroeconomists are confronting the reality that the sky did not fall, even as the United States swung from a $236 billion surplus in the 2000 fiscal year to a $779 billion deficit in 2018. By their old theories, high deficits and debt should have caused interest rates and inflation to rise, and government borrowing should have “crowded out” capital from the private sector.

 

At a minimum, the old rules simply seem not to apply in a world that has free-flowing capital; an aging population; and stubbornly low inflation and interest rates. Or, more controversially, maybe those rules were never really an accurate description of how economics works in a country like the United States that can borrow in its own currency.

How did everyone — liberals and conservatives, politicians and economists — get so comfortable with debt?

 

The Clinton surpluses to Bush deficits

The start of the 21st century was a triumphalist moment for the United States economy. The unemployment rate was at its lowest in decades, workers’ wages were rising, inflation was well contained and the stock market had reached staggering highs.

The bipartisan conventional wisdom was that fiscal conservatism was a meaningful part of why: In the early 1990s, tax increases signed by George H.W. Bush and Bill Clinton, combined with spending restraint, lowered projected deficits. That, in turn, generated lower interest rates. Global bond markets and the Federal Reserve rewarded fiscal restraint.

Lower interest rates, in this telling, fueled an investment boom generating higher productivity — and all the good things about the turn-of-the-century economy.

To those in charge, this story of cause-and-effect seemed almost self-evident. But even then, there were reasons to question it.

For one thing, the cause-and-effect might have been backward. Maybe the economic boom caused the surpluses, not the other way around. And continuing fiscal surpluses meant a falling supply of Treasury bonds, the bedrock of the global financial system. Could that have been destabilizing?

Some economists thought so, for example, Stephanie Kelton, who as a young scholar studied under the groundbreaking Cambridge economist Wynne Godley. In their thinking, the American combination of government budget surpluses and current account deficits — meaning importing more than exporting — would cause private debt to rise. And private debt, they said, is more dangerous than the public kind; private borrowers cannot create money from thin air.

In 2001, the boom turned to recession. The Bush administration sought lower income tax rates, especially for investment income, and passed them in 2001 and 2003. In 2003, Congress and the administration created an expensive new Medicare prescription drug benefit. The country faced the new costs of wars in Afghanistan and Iraq. The surpluses vanished.

Interest rates and inflation remained low throughout the Bush years even as deficits soared, and rather than being crowded out by government borrowing, capital was freely available to private borrowers — so much so that it fueled a housing bubble.

Then came the global financial crisis.

The steep contraction in the economy in 2008 and the first half of 2009 caused tax revenues to plummet and social safety net spending to soar. The Obama administration advanced a deficit-financed $787 billion package of spending and tax cuts to contain the economic damage.

But strikingly, even amid soaring deficits, President Obama embraced the language of the old Clinton-era consensus. “It has never been more important to ensure that as our economy recovers, we do what it takes to bring this deficit down,” he said in his first address to Congress in early 2009.

When Republicans won control of the House of Representatives in 2010, in part by assailing the enormous Obama deficits, there was a bipartisan view that the United States was at risk of a fiscal crisis. The concern was that high debt would cause international investors to lose confidence in Treasury bonds and dump them, sending interest rates soaring and cratering the economy.

The deficit did come down in the late Obama years, in part after Republicans insisted on budget cuts in so-called sequestration policies and the Obama administration insisted on allowing some of the Bush tax cuts to expire, raising taxes.

When President Trump took office, Republicans in Congress initially discussed lowering corporate tax rates while keeping the government’s revenue stable with a “destination-based cash flow tax.”

But the problem with a deficit-neutral tax change is that the losers, especially retailers in this case, tend to be more vocal than the winners. Congressional Republicans agreed on the deficit-widening parts of tax reform, cutting the corporate income tax rate to 21 percent from 35 percent, reducing taxes on many “pass-through” businesses, and more. They couldn’t agree on offsetting moves to raise revenue.

In October 2017, the Senate passed rules allowing a tax bill that raised the deficit by $1.5 trillion over 10 years. And just weeks after passing tax cuts, large bipartisan majorities in Congress voted on spending bills that increased federal outlays by about 13 percent.

“It just didn’t seem like there was any way to get to deficit neutral or revenue neutral,” said former Senator Bob Corker of Tennessee, who ultimately voted for the tax cuts after voicing deficit concerns along the way. “Do I wish it was revenue neutral? Yes. Do I wish we had not turned around and voted for $2 trillion in spending that was unpaid for? Absolutely.”

Mr. Corker says tax cuts are fulfilling their goal of making American businesses more competitive, though he said he still worried about Congress’s retreat from fiscal probity.

“I was there for 12 years, and I think for eight or nine years of that time I felt Congress would deal with fiscal issues — I see no hope of that currently,” he said.

Yet again, though, there has been scant evidence that this is doing the kind of damage to the economy that the old models predicted. The United States government can borrow money for 30 years for a smidgen over 3 percent. It was 6.5 percent back when surpluses reigned.

Letting borrowers be borrowers

Larry Summers was the last Treasury secretary to oversee a full year of fiscal surplus, in the final days of the Clinton administration. Last month, he and the economist Jason Furman published an article titled “Who’s Afraid of Budget Deficits: How Washington Should End Its Debt Obsession.”

Focusing on limiting public debt, they argued, had hamstrung the nation’s ability to invest in things with long-term benefits, namely education, health care and infrastructure.

“The basic idea that if you issue too much debt you will crowd out large amounts of valuable private capital investment was a reasonable view in the early to mid-1990s,” Mr. Summers, a Harvard economist, said in an interview. With very low interest rates worldwide, it isn’t today, he said.

Larry Summers at his confirmation hearing to be Treasury secretary in 1999.CreditDouglas Graham/Congressional Quarterly, via Getty Images

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Larry Summers at his confirmation hearing to be Treasury secretary in 1999.CreditDouglas Graham/Congressional Quarterly, via Getty Images

Mr. Summers and other non-alarmist economists are not suggesting that debt never matters.

They say that in this environment — with low interest rates to the horizon, no evident inflation pressures, and with worthwhile policies that could enhance the nation’s long-term outlook — it’s foolish not to borrow money.

Mr. Blanchard, the former I.M.F. chief economist, emphasizes that interest rates are comfortably below the rate at which the economy is growing. That means that, despite high debt levels in the United States, it shouldn’t matter if the nation keeps borrowing money because its capacity to pay is growing faster than interest costs.

Some take the argument even further.

Ms. Kelton, who went from her early research on debt to advise Senator Bernie Sanders and other politicians on the left, argues that a currency-issuing government needn’t worry that deficits will lead to a fiscal crisis. Rather, inflation becomes a risk if spending outpaces the finite supply of workers and productive capacity.

The political implication of modern monetary theory is that you should lay out what you believe is an important priority for the country, and if you have the votes, enact it. Ms. Kelton said Presidents Trump and George W. Bush behaved as if they were M.M.T. adherents, and as a result had greater flexibility to enact their agenda than a more fiscally conservative president would.

Even the members of Congress on the left aren’t ready to disregard fiscal constraints entirely. But they are focusing on the upside of their policies.

When Senator Elizabeth Warren was asked if she believed in the modern monetary theory approach, she told Bloomberg Television: “It’s only when we talk about the things that go to hard-working Americans that Republicans seem to get religion about the national debt. Debt matters. There comes a point where debt matters. But what I care about is that we need to rethink our system in a way that is genuinely about investments that pay off over time.”

Moreover, Ms. Warren has proposed a wealth tax on assets over $50 million. Ms. Ocasio-Cortez has supported a 70 percent tax rate on income over $10 million. Moves like those would reduce the deficit impact of their spending proposals. But both speak of those strategies as desirable on their own terms, for fairness, rather than as necessary sacrifices to pay for aggressive climate change action or cheaper college access.

It’s as if Democrats and Republicans were divorced parents who share custody — and elected Democrats feel that the Republicans are the parent constantly giving the children pizza and sweets, while the Democrats worry about healthy eating.

“There’s a sense of ‘Why do we always have to be the fiscal grown-ups?’ ” said Jared Bernstein, who worked in the Obama administration and is now a senior fellow at the Center on Budget and Policy Priorities. “It puts your party at a disadvantage if we’re the ones saying you have to eat your spinach all the time.”

The hawks’ warning

Republicans may cut taxes with abandon, and Democrats seem increasingly ready to undertake their agenda with similar disregard to fiscal consequences. But there remains a politically homeless group: people who see profound risks in the bipartisan willingness to embrace deficit spending.

In 2011, Erskine Bowles, who was co-chairman of a committee aimed at long-term deficit reduction, predicted that a fiscal crisis could arrive in two years.

That didn’t happen. But Mr. Bowles believes that in the generation to come, there will be regrets over the current era of large deficits even in a time of economic strength: “I’m confident many Americans will wonder why didn’t those old guys make some of these tough decisions 20 to 30 years ago.”

Neil Irwin is a senior economics correspondent for The Upshot. He previously wrote for The Washington Post and is the author of “The Alchemists: Three Central Bankers and a World on Fire.” @Neil_Irwin • Facebook

A version of this article appears in print on Feb. 24, 2019, on Page SR3 of t