Debt And Deficits With The Coronavirus

For all the suffering caused by the pandemic, one important positive effect is that it may lead to clearer thinking about government debt and deficits. To Congress’s credit, it has focused on dealing with the problem of sustaining the country through a period in which much of the economy is shut down, rather than worrying about the large deficit it will run this year, as well as the amount it is adding to the national debt. (I strongly suspect that this would not be the situation if a Democrat was in the White House. In that case, most Republicans would likely be making angry speeches feigning outrage over the burden that Obama, Biden, etc. was imposing on our children and grandchildren.)

Anyhow, the story on the deficit and debt are both simpler and more complicated than is generally imagined. The basic story of the deficit is, are we pushing the economy too hard. The issue is whether the additional demand created by a government deficit is exceeding the economy’s ability to produce goods and services, leading to inflation.

There is an intermediate step in this story. If the Federal Reserve Board correctly sees excessive demand leading to inflationary pressures, then it may act to head off actual inflation by raising interest rates. In that case, the problem of a large budget deficit would be high interest rates in the economy. High interest rates will reduce demand by lowering housing construction, public and private investment, and consumption. High interest rates will also raise the value of the dollar, reducing net exports. This reduction in demand prevents inflation, but means that we will have less investment for the future.

Of course, the Fed may also raise interest rates out of a mistaken belief in inflationary risks, in which case the Fed was the cause of high interest rates, not the fact that the economy was being pushed beyond its limits. That was likely the case in 2018 when the Fed raised interest rates four times. As it turned out, there was very little evidence of accelerating inflation and wage growth peaked in early 2019, in spite of the extraordinarily low unemployment rate last year.

Anyhow, the immediate concern with large budget deficits is whether they are leading to too much demand in the economy, and therefore generating either high inflation or high interest rates. Ordinarily, a $2 trillion boost to demand (roughly 10 percent of GDP) would lead to a serious problem of inflation, especially with an economy operating at 3.6 percent unemployment. However, tens of millions of workers are now losing their paychecks, so consumption demand would be collapsing without the additional spending and tax cuts. The purpose of this rescue plan is to allow families to more or less keep themselves whole through a period in which large segments of the economy are shut down.

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Moon Kil Woong 5 months ago Contributor's comment

Sadly there are no fiscally conservative parties in the US anymore. The Republicans time and again mouth the belief but then when in power end up spending more than Democrats. Reagan was popular but created massive deficits compared to the Democrats before. Bush Sr. was fiscally conservative but could only staunch Reagan's unprecedented fiscal bleeding at the cost of a mild recession (which made him lose reelection). Then Bush Jr. annihilated the US budget again by starting another war and being fiscally inept. And now Trump is proud of mishandling the Corona outbreak and thinks mailing people checks with his signature is going to help.

Fiscal conservatives need a new party and need enough votes to block spending by either party unless it is fiscally responsible. Furthermore, they need a party of fiscally conservative members, not just a party of obstructionists. Only this way can we begin a discussion on what is truly fiscally best for America and both parties will need to present proposals that are workable on health care, welfare, defense, etc. Sadly even if one was started today and had 10% of the votes in Congress, it may be too late to control the beast.

David J. Williamson 5 months ago Member's comment

This comment should be read by all. It's exactly correct.