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Worst-of-both-worlds fiscal policy


A lot of the debate over deficits right now comes down to how you feel about interest rates. Normally, interest rates should be a conversation-ending indicator. If our deficits are too high, interest rates on government debt should be high, too, as that's how the market would compensate for the risk that we won't pay people back. But interest rates, of course, are very low. Even historically low. That should mean that our deficits aren't a problem, at least not in the short term. That's the stance taken by Paul Krugman and Brad DeLong.

But these are abnormal times, and some people think that our low interest rates are a product of, in the first case, catastrophes everywhere else, and in the second case, the fact that the market is staffed by idiots who miss important information for a long time and then all panic about it at once (remember the subprime crisis?). Rather than showing us that we don't have a problem, our low interest rates, according to this school of thought, are masking the fact that we do -- and making the eventual reckoning worse.

I don't have too much of a dog in this fight. I mainly think it's unrelated to the question of whether we added $100 billion in stimulus over the next year. The market may be dumb, but it's not completely insane. The government has about $12 trillion in total debt right now. And that, on its own, is actually okay: It's the rapid growth of entitlements in the future that poses the real problem. Amid all that, a single-year charge of $100 billion is such a vanishingly small addition to our long-term debt that neither including it nor deleting it is going to have any effect on our fiscal condition.

Moreover, I've now been to enough deficit panels and workshops to know that everyone who studies this stuff thinks that the only way we'll actually make any substantial changes to our long-term policies is within the context of a crisis. So in practice, I wonder how much this debate matters in terms of long-term fixes -- the ones that matter -- as opposed to short-term stimulus. Creating a lot of uncertainty about our deficit might be enough to push people away from stimulus, but it seems far from enough to do anything about our long-term deficit.

It seems we're getting the worst of both worlds: The argument over deficits is keeping us from doing what we need to do to help the economy grow right now, but it isn't going to be enough to get us to do what we need to do to help the economy grow later, either. And the outcome of that could be ugly: If growth is anemic when the eventual fiscal crisis does come, that's going to make a response much, much harder.

Graph credit: Committee for a Responsible Federal Budget.

By Ezra Klein  |  June 14, 2010; 11:42 AM ET
Categories:  Budget  
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Next: Stimulus isn't free


A very good analysis.

The crisis doesn't seem far away -- and I'll stick with my prediction made last year that a true fiscal calamity will come mid-2011. That the legislatures of both Vermont and Pennsylvania are re-routing (health) funds to other priorities suggests a growing problem plus growing unity: now everyone is essentially in the same pot, forced to choose between food and medicine.

The unity of crisis might actually help resolve the crisis.

Posted by: rmgregory | June 14, 2010 12:09 PM | Report abuse

rmgregory is probably one of those who, like Bush and McCain, were saying in the summer of 2008 the economy was "sound".

The useless, and purely ideologically driven, Larry Kudlow, also comes to mind.

Posted by: Lomillialor | June 14, 2010 12:50 PM | Report abuse

Typical republican strategy, cripple govt for 8 years and then complain that it isn't working well enough. The lack of basic understanding of Keynian economics by conservatives is staggering. Just like their decision to run huge deficits when the economy appeared to booming, they want to cut spending in a recession. Their logic is exactly backwards.

Posted by: srw3 | June 14, 2010 1:05 PM | Report abuse

*****Ezra writes: The government has about $12 trillion in total debt right now.*******

Ezra: just wanted to pedantically point out a pet peeve of mine: you cite a national (or "gross") debt figure, but the graph you provide is for the public debt (which, last time I looked, wast at about 66% of GDP, or just shy of $10 trillion). Both figures are relevant (I think for the most purposes the latter, smaller figure is more meaningful, because the former figure puts excessive emphasis on the fact that one particular public program -- Social Security -- is not pre-funded when in fact NO federal spending is pre-funded -- but I digress), but at the very least, I would suggest using graphs that directly match the point you're trying to make, or vice versa.

The national debt figure has us teetering on the brink of a debt/GDP ratio perilously close to 100% of GDP, which sounds a lot more scary than the public debt figure, which is about where we were when Eisenhower was president.

Posted by: Jasper999 | June 14, 2010 1:14 PM | Report abuse

"The lack of basic understanding of Keynian economics by conservatives is staggering. Just like their decision to run huge deficits when the economy appeared to booming"

In all fairness, that's what Bush and the Republicans did, but is not a conservative position. While there are "big government" conservatives, they are at odds with classical conservatism, and for good reason: debts have to be paid, and entitlements (like Medicare Part D) can end up going on forever, no matter how expensive they get.

Classical conservatism would suggest that you decrease debts. Failing that, you do not increase debts. Failing that, you increase debts for one time expenditure. You would never, under any circumstances, increase deficits in order to fund an ongoing liability with no ceiling on costs. Which is what Bush did.

@Lom: You know who was saying the economy was teetering on the brink of collapse in 2008, and even alluding to it in 2007? Glenn Beck. So, there ya go.

Posted by: Kevin_Willis | June 14, 2010 1:44 PM | Report abuse

Glen Beck also said Obama was creating concentration camps and many other goof-balled statements. He's probably just as often correct as Homer Simpson. So there ya go.

Classical economic conservatism has nothing to do with Reagan either. He's the one who started cutting taxes while raising spending (creating massive debt). Why even bring up classical economic conservativism? I can't think of an elected Republican in 30 years or so who follows it. Obama and Clinton are the closest things to classical economic conservatism since Nixon. Its funny how the progressives are today's economic conservatives, and conservatives are today's economic liberals.

Posted by: Lomillialor | June 14, 2010 2:20 PM | Report abuse

Nice system we have here—ignoring problems we can see until they become problems we can't solve. Call it the BP Syndrome.

Posted by: tomcammarata | June 14, 2010 3:11 PM | Report abuse

To borrow from tomorrow believing tomorrow never comes is insane. Welcome to the asylum.

But, maybe these academians can "talk" us back to prosperity.

They must think we voted in the Democrat's US Senate primary in South Carolina.

Posted by: BluePelican | June 14, 2010 3:24 PM | Report abuse

This piece on my website might add interesting fuel to the debate. It was written some time ago but is quite current as to the ruling mood on the economy. Please visit and comment as you will.

Posted by: jmconvey | June 14, 2010 3:57 PM | Report abuse

Hysteria? Dig another trillion is no sweat?

Posted by: read5 | June 14, 2010 3:58 PM | Report abuse

The current scenario being played out at the state and local levels, starved by major drops in transfer payments from the Federal government and unable to print money, is a good indicator.

Where I live in MD, citizens threw themselves off of roofs opposing proposed new county taxes for the next FY. So the Commisioners (sly dogs!) said "Fine" and promptly cut the budget by close to 20%. And now the whining is at full volume!!!

This entire situation was predicted long in advance from many quarters, but no one roused themselves to action until they felt either the increases or the cuts. Which supports your "The worst of both worlds" hypothesis. Get ready, its going to be a harrowing experience!!!

Posted by: vardo | June 14, 2010 4:36 PM | Report abuse

On what planet do most DC pundits like Ezra spend most of their time? "12 trillion is okay" That is what Greece said a few years ago (in proportion)& gee it did not work out so well.

Who (beside Ron Paul and crew) will be the second to stand up and say the American Empire is unsustainable? ( and other sensible proposals)

I will be dead in about 10 years, so you youngens can inherit the mess.

Posted by: wooldridge1 | June 14, 2010 5:04 PM | Report abuse

The Federal Government tells the American people they must break their addiction to cheap easy credit and borrowing, but then says, they can do it, just a little longer, and a little longer, and a little longer ?

Posted by: jjoyce6018 | June 14, 2010 6:02 PM | Report abuse

As long as numpties like Ezra Klein refuse to recognize the unfunded liability for Medicare and Social Security they somehow think we can borrow our way out of debt.

In the end, overspending and over-regulation in combination with tax increases will lead to disaster, and the fact that Bush was criticized for overspending somehow makes it okay to over-regulate and overspend while imposing new taxes and crippling healthcare costs on the taxpayers of this country.

"Economic and Domestic Policy, and Lots of It".........Mostly, it's diarhea from this guy.

Posted by: buggerianpaisley1 | June 15, 2010 12:41 AM | Report abuse

Like Ezra I have been to my fair share of deficit panels and workshops. We know what the solutions are. The same experts that have testified before the house and senate budget committees are now testifying before the fiscal commission. The hard part is not going to be finding a solution but selling it to the American people. Last I checked congress had an approval rating of around 21%. Which means most of us don't trust pretty much everything they do. Congress is going to have to do a better job of talking to the people outside of soundbites and attacks on the other side.

Then if they can convince the people that the solution is what is best for the country they will have to stick to the plan. As most of us know and evidence by our current situation, congress is not very good at long-term planning.


Posted by: wecantpaythattab | June 15, 2010 12:57 PM | Report abuse

This crisis represents a structural reset of the economy to a lower, sustainable level of activity, say a $13.5 trillion GDP instead of $14.5 trillion. The $1 trillion gap right now is bridged by adding $2 trillion to our debt each year instead of the $1 trillion under Bush.

We should be learning from Japan's "Lost Decade" right now and attack the root cause of our economic problem, which is consumer debt levels, still near record levels of about 122% of disposable income. Japan did massive deficit spending for a decade and its recovery remains, in Paul Krugman's words, "provisional."

A little history: Japan had a massive commercial and stock bubble that burst in 1990, rendering its banks and many corporations insolvent. Japanese firms focused on paying down debt instead of borrowing and investing like firms usually do, taking a whopping 22% chunk out of GDP. Japan had three choices: Depression, stimulus spending or take many of its major institutions through bankruptcy so they would invest again. It chose stimulus.

By failing to forcibly and timely de-leverage its corporations, Japan had a lost decade of massive deficit spending, minimal real growth, and a debt to GDP ratio of nearly 200% today.

We do not have to share this fate. Instead of a decade of deficit spending, we could instead tackle the household debt problem. Write down mortgages to market value, as economists Stiglitz, Roubini, and Ferguson advocate. Write off 50% of credit card debt and cap interest rates at 10%. To prevent this from every happening again, require a 20% down payment for cars and homes.

If this renders some banks insolvent, bail them out or take them through bankruptcy and impose haircuts on their bondholders. It will be much cheaper than a lost decade and the $1 trillion annual interest payments that will go with that.

If we are foolish and commit to spending another $1-5 trillion in stimulus over the next decade, it has to be spent in a way that builds our ability to compete in the future and get rid of our trade deficit. That means nuclear plants and electric car infrastructure, to get rid of our dependence on foreign oil and get our defense spending down.

It means protectionism and capital inflow controls, to prevent our folks from borrowing from China to buy Chinese goods, instead buying them here. We have a $250 billion trade deficit with China right now.

Posted by: Factified | June 16, 2010 1:01 AM | Report abuse

Ezra Klein,
It does not take an economics professor to understand that the current economic problem is "Insufficient funds" to maintain the present fiscal needs.
Economics is a people devised system to provide the exchange of goods and services; it is not a religion that worships the rich and powerful. If the rich and powerful want to remain rich and powerful they are going to have to give up their greed and accept a fair and equitable world economic system that is stable and provides the funds to support quality lifestyles for all of earth's people. There are adequate resources to make this accomplishment possible. All it takes is the necessary organization, people power and capital.
People have to get over their anal retentive sickness and do what is necessary, right and good. It is people's survival at stake.

Posted by: OchamsRazor | June 17, 2010 2:19 AM | Report abuse

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