The Deficit Argument

Kevin Hassett believes that the U.S. budget deficit is a matter more of politics than economics. On the issue of deficits and interest rates, he writes

My own view is that there are many close substitutes for U.S. government bonds in the world today (Fannie Mae's, corporate bonds, foreign government bonds) and that the historical swings in U.S. deficits are so small relative to the stock of existing debt that it would be miraculous if debt did have much of an effect on interest rates

Brad DeLong would want to know what the meaning of "much" is. More important, DeLong worries that current fiscal policy is not a "swing" in the deficit but a large, permanent change.

The effect of the policy (and forecast) changes between 2003 and 2004 has been to widen future deficits (and eliminate future surpluses) by an amount that averages 2.7% of GDP--roughly $300 billion dollars a year--in each of the next seventeen years (and thereafter as well). The Bush Administration policy changes look much, much, much more like a permanent widening of the deficit than a transitory one-year fiscal stimulus that is then reversed.

All economists would agree that for the government to plan to incur an ever-increasing debt burden (cumulative deficit) as a percent of GDP is not a good thing. One can argue about the impact on interest rates, in part because interest rates and deficits are both endogenous variables that are affected by many factors. But in my view, the debate over how much deficits affect interest rates sheds more heat than light on the topic of fiscal policy. The real question is whether the debt burden is going to outgrow the economy, or vice-versa.

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