Thursday, May 13, 2010

“Deficits Don’t Matter”

Remember all the grief that Dick Cheney got for saying that “deficits don’t matter”? At the time, his words were widely interpreted as an expression of economic illiteracy and political opportunism. Here’s James Galbraith, an accomplished left-of-center economist, saying substantially the same thing in an interview with Ezra Klein to rebut the notion that the welfare state is becoming fiscally unsustainable:

“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. . . .

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. . . .

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.”
I’m no economist, so don’t rely on me to tell you exactly what, if anything, is wrong with the picture that Galbraith's painting. It sounds to me that he’s turning the significant-sounding claim that “a welfare state guaranteeing its members cradle-to-grave security is fiscally sustainable” into either an empty tautology or an untestable metaphysical principle. Can it really be that the question keeping European finance ministers up at night is just the symptom of a conceptual misunderstanding?

1 comment:

Anonymous said...

I'm no economist either but I have to believe that it must be the case that the bigger the deficit as a % of GDP, the more likely it is to matter. As you suggest, this is playing out in real time right now in Europe. Stay tuned Mr. Galbraith.