A new article from the Economic Policy Institute busts several of the myths relating to the deficit and the national debt and shows that the focus of many politicians and policy analysts is misguided and could undercut the fragile economic recovery.
Unfortunately, a dangerous consensus has emerged that policymakers should set specific goals for reducing the deficitover the next ten years in order to stabilize the national debt as a share of the economy, and that stabilizing the national debt should be a top priority of our economic policy. Some of the more familiar claims are that we need to stabilize the debt with $1.4 or $1.5 trillion in deficit reduction over the next decade.EPI author Ethan Pollack shows that these assumptions are unfounded:
[EPI’s] analysis shows that the debt ratio can be stabilized with less than $1.4 trillion. And more importantly, there actually isn’t a single minimum target necessary; if coupled with near-term stimulus, the debt ratio could be stabilized without any deficit reduction whatsoever.
There are two reasons that stimulus makes stabilization easier rather than harder. First, the economic boost from properly constructed stimulus (i.e., policies that have high multipliers) can itself reduce the debt/GDP ratio over time. Partly this is because more people employed means higher tax revenues and less reliance on the social safety net (thereby reducing debt incurred as the cyclical budget deficit falls), and also because a larger economy makes the dollar value of the public debt more manageable.
The second reason:
Larry Summers and Brad DeLong have also found that deficit-financed fiscal stimulus is likely fully self-financing, even in dollar terms when one considers the long-term impact. Some of this is related to historically low interest rates, but the more significant effect is the avoidance of continued economic scarring, which occurs when inadequate demand reduces the economy’s long-run potential as productive resources go unused and atrophy (e.g., shuttered factories and forgotten labor skills).
Pollack says that while stabilizing the debt is an appropriate goal in normal economic times, these are not normal economic times. The economy is projected to remain below potential until 2018.
“Both the timing and the composition of any deficit reduction should be conditioned on the actual state of the economy,” Pollack writes, and deficit reduction that imposes a drag on growth should not begin until the economy is closer to full employment. The problem with the type of measures most commonly proposed to stabilize the debt is that they could derail the weak recovery.
Another big problem with promoting an aggressive 10-year deficit reduction target is that it suggests that stabilization acts as a hard budget constraint...This suggestion, however, is completely wrong, and its wrongness reveals the fallacy of the whole idea that there is a specific number needed to achieve debt stabilization.
Even without additional stimulus, Pollack argues, the debt could be stabilized by much less deficit reduction than others have suggested--as little as $670 billion could do it. Pollack also points to the abundant economic literature showing that claims that any particular level of debt stabilization is required are hogwash.