Galbraith: The danger posed by the deficit ‘is zero’

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Galbraith: The danger posed by the deficit ‘is zero’

By Ezra Klein | May 12, 2010; 3:50 PM ET

James Galbraith is an economist and the Lloyd M. Bentsen Jr. chair in government and business relations at the University of Texas at Austin. He's also a skeptic of the prevailing concern over America's long-term deficit. With many people now comparing America's fiscal condition to Greece, I spoke with Galbraith to get the other side of the argument. An edited transcript of our conversation follows.

EK: You think the danger posed by the long-term deficit is overstated by most economists and economic commentators.

JG: No, I think the danger is zero. It's not overstated. It's completely misstated.

EK: Why?

JG: What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn't be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.

So there are two possibilities here. One is the theory is wrong. The other is that the market isn't rational. And if the market isn't rational, there's no point in designing policy to accommodate the markets because you can't accommodate an irrational entity.

EK: Then why are the bulk of your colleagues so worried about this?

JG: Let's push a bit deeper on the CBO forecasts. They publish a baseline set of projections. One of those projections holds the economy will return to a normal high-employment level with low inflation over the next 10 years. If true, that would be wonderful news. Go down a few lines and they also have the short-term interest rate going up to 5 percent. It's that short-term interest rate combined with that low inflation rate that allows them to generate, quite mechanically, these enormous future deficit forecasts. And those forecasts are driven partially by the assumption that health-care costs will rise forever at a faster rate than everything else and by interest payments on the debt will hit 20 or 25 percent of GDP.

At this point, the whole thing is completely incoherent. You cannot write checks to 20 percent to anybody without that money entering the economy and increasing employment and inflation. And if it does that, then debt-to-GDP has to be lower, because inflation figures into how much debt we have. These numbers need to come together in a coherent story, and the CBO's forecast does not give us a coherent story. So everything that is said that is based on the CBO's baseline is, strictly speaking, nonsense.

EK: But couldn't there be a space between the CBO being totally correct and the debt not being a problem? It seems certain, for instance, that health-care costs will continue to rise faster than other sectors of the economy.

JG: No, it's not reasonable. Share of health-care cost would rise as part of total GDP and the inflation would rise to be nearer to what the rate of health-care inflation is. And if health care does get that expensive, and we're paying 30 percent of GDP while everyone else is paying 12 percent, we could buy Paris and all the doctors and just move our elderly there.

EK: But putting inflation aside, the gap between spending and revenues won't have other ill effects?

JG: Is there any terrible consequence because we haven't prefunded the defense budget? No. There's only one budget and one borrowing authority and all that matters is what that authority pays. Say I'm the federal government and I wish to pay you, Ezra Klein, a billion dollars to build an aircraft carrier. I put money in your bank account for that. Did the Federal Reserve look into that? Did the IRS sign off on it? Government does not need money to spend just as a bowling alley does not run out of points.

What people worry about is that the federal government won't be able to sell bonds. But there can never be a problem for the federal government selling bonds. It goes the other way. The government's spending creates the bank's demand for bonds, because they want a higher return on the money that the government is putting into the economy. My father said this process is so simple that the mind recoils from it.

EK: What are the policy implications of this view?

JG: It says that we should be focusing on real problems and not fake ones. We have serious problems. Unemployment is at 10 percent. if we got busy and worked out things for the unemployed to do, we'd be much better off. And we can certainly afford it. We have an impending energy crisis and a climate crisis. We could spend a generation fixing those problems in a way that would rebuild our country, too. On the tax side, what you want to do is reverse the burden on working people. Since the beginning of the crisis, I've supported a payroll tax holiday so everyone gets an increase in their after-tax earnings so they can pay down their mortgages, which would be a good thing. You also want to encourage rich people to recycle their money, which is why I support the estate tax, which has accounted for an enormous number of our great universities and nonprofits and philanthropic organizations. That's one difference between us and Europe.

EK: That does it for my questions, I think.

JG: I have one more answer, though! Since the 1790s, how often has the federal government not run a deficit? Six short periods, all leading to recession. Why? Because the government needs to run a deficit, it's the only way to inject financial resources into the economy. If you're not running a deficit, it's draining the pockets of the private sector. I was at a meeting in Cambridge last month where the managing director of the IMF said he was against deficits but in favor of saving, but they're exactly the same thing! A government deficit means more money in private pockets.

The way people suggest they can cut spending without cutting activity is completely fallacious. This is appalling in Europe right now. The Greeks are being asked to cut 10 percent from spending in a few years. And the assumption is that this won't affect GDP. But of course it will! It will cut at least 10 percent! And so they won't have the tax collections to fund the new lower level of spending. Spain was forced to make the same announcement yesterday. So the Eurozone is going down the tubes.

On the other hand, look at Japan. They've had enormous deficits ever since the crash in 1988. What's been the interest rate on government bonds ever since? It's zero! They've had no problem funding themselves. The best asset to own in Japan is cash, because the price level is falling. It gets you 4 percent return. The idea that funding difficulties are driven by deficits is an argument backed by a very powerful metaphor, but not much in the way of fact, theory or current experience.

[Ban Hammer 13,345]

Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn't be 4 percent and change now.

yeah, let's trust the instincts of the market, given the recent bailouts.

[SMOKE 1,426]

i hope he is right.

[one...two...tree 2,762]

That was the basic theory of Reagan's economic advisors - that a running deficit doesn't matter much. Keynesian economists have stated though that it is beneficial to cut down the deficit in during good economic times.

[luckytxn 2,264]

I think he is wrong. Having no debt is a sign of strength. He is right to a degree that the money we pay on debt is being placed from the private and Feds to the marketplace and thus that money comes into play. The one thing though is that when the debts get so huge that the budget has become hijacked by it. This is a huge amount of money that is being siphoned away to just service the debt.

[one...two...tree 2,762]

How well did Reagan succeed in cutting government spending, surely a critical ingredient in any plan to reduce the role of government in everyone's life? In 1980, the last year of free-spending Jimmy Carter the federal government spent $591 billion. In 1986, the last recorded year of the Reagan administration, the federal government spent $990 billion, an increase of 68%. Whatever this is, it is emphatically not reducing government expenditures. Sophisticated economists say that these absolute numbers are an unfair comparison, that we should compare federal spending in these two years as percentage of gross national product. But this strikes me as unfair in the opposite direction, because the greater the amount of inflation generated by the federal government, the higher will be the GNP. We might then be complimenting the government on a lower percentage of spending achieved by the government's generating inflation by creating more money. But even taking these percentages of GNP figures, we get federal spending as percent of GNP in 1980 as 21.6%, and after six years of Reagan, 24.3%. A better comparison would be percentage of federal spending to net private product, that is, production of the private sector. That percentage was 31.1% in 1980, and a shocking 34.3% in 1986. So even using percentages, the Reagan administration has brought us a substantial increase in government spending.

Also, the excuse cannot be used that Congress massively increased Reagan's budget proposals. On the contrary, there was never much difference between Reagan's and Congress's budgets, and despite propaganda to the contrary, Reagan never proposed a cut in the total budget.

Deficits. The next, and admittedly the most embarrassing, failure of Reaganomic goals is the deficit. Jimmy Carter habitually ran deficits of $40-50 billion and, by the end, up to $74 billion; but by 1984, when Reagan had promised to achieve a balanced budget, the deficit had settled down comfortably to about $200 billion, a level that seems to be permanent, despite desperate attempts to cook the figures in one-shot reductions.

This is by far the largest budget deficit in American history. It is true that the $50 billion deficits in World War II were a much higher percentage of the GNP; but the point is that that was a temporary, one-shot situation, the product of war finance. But the war was over in a few years; and the current federal deficits now seem to be a recent, but still permanent part of the American heritage.

One of the most curious, and least edifying, sights in the Reagan era was to see the Reaganites completely change their tune of a lifetime. At the very beginning of the Reagan administration, the conservative Republicans in the House of Representatives, convinced that deficits would disappear immediately, received a terrific shock when they were asked by the Reagan administration to vote for the usual annual increase in the statutory debt limit. These Republicans, some literally with tears in their eyes, protested that never in their lives had they voted for an increase in the national debt limit, but they were doing it just this one time because they "trusted Ronald Reagan" to balance the budget from then on. The rest, alas, is history, and the conservative Republicans never saw fit to cry again. Instead, they found themselves adjusting rather easily to the new era of huge permanent deficits. The Gramm-Rudman law, allegedly designed to eradicate deficits in a few years, has now unsurprisingly bogged down in enduring confusion.

Read more: The Myths of Reaganomics - Murray N. Rothbard - Mises Daily http://mises.org/daily/1544#ixzz0nvPdvizF

[Pinocchio Liberal 268]

Look and sound familiar? Greece?

In its earliest form, the Cloward-Piven strategy applied Alinsky's principle to the specific area of welfare entitlements. It counseled activists to create what might be called Trojan Horse movements - mass movements whose outward purpose seemed to be providing material help to the downtrodden, but whose real purpose was to draft poor people into service as revolutionary foot soldiers.

The specific function of these Trojan Horse movements was to mobilize poor people en masse to overwhelm government agencies with a flood of demands beyond the capacity of those agencies to meet. The flood of demands was calculated to break the budget, jam the bureaucratic gears into gridlock, and bring the system crashing down. Fear, turmoil, violence and economic collapse would accompany such a breakdown - providing perfect conditions for fostering radical change. That, at least, was the theory behind the Cloward-Piven strategy.

Edited May 14, 2010 by Col. Lingus

[one...two...tree 2,762]

Look and sound familiar? Greece?

In its earliest form, the Cloward-Piven strategy applied Alinsky's principle to the specific area of welfare entitlements. It counseled activists to create what might be called Trojan Horse movements - mass movements whose outward purpose seemed to be providing material help to the downtrodden, but whose real purpose was to draft poor people into service as revolutionary foot soldiers.

The specific function of these Trojan Horse movements was to mobilize poor people en masse to overwhelm government agencies with a flood of demands beyond the capacity of those agencies to meet. The flood of demands was calculated to break the budget, jam the bureaucratic gears into gridlock, and bring the system crashing down. Fear, turmoil, violence and economic collapse would accompany such a breakdown - providing perfect conditions for fostering radical change. That, at least, was the theory behind the Cloward-Piven strategy.

fvckin plagiarist.

[mawilson 2,133]

Another Krugman-like idiot economist.

You don't have to go very far to see the danger posed by the deficits - just look at Greece.

[mawilson 2,133]

The other is that the market isn't rational. And if the market isn't rational, there's no point in designing policy to accommodate the markets because you can't accommodate an irrational entity.

What an idiotic argument.

The market is doing fine today, hence there's no problem.

The market was doing fine in 2007 too, and yet we had a near collapse of the economy in 2008.