<$BlogRSDURL$>
Friday, May 07, 2004

Economics is not a matter of opinion 

In a speech yesterday, Alan Greenspan warned of the economic dangers of running large budget deficits. He said that running uncorrected deficits raises long-term interest rates, which constrain long-term economic growth. The Bush administration responded that the link between deficits and interest rates isn't strong.

The administration is trying to get people to buy into the line that whether or not running repeated deficits is good for the economy is really a matter of opinion, much as voters might have an opinion on the costs and benefits of an education bill or a new gun registration law. Their argument is that they believe one thing, Greenspan believes another, and no one really knows who's right.

The problem is that any serious economist, including Gregory Mankiw, the Head of Bush's Council of Economic Advisors, will tell you that running deficits unambiguously drives up long-term rates. This happens because governments must issue debt in order to finance budget deficits, and larger deficits require more debt than smaller deficits. The problem is that there are a finite number of buyers willing to hold debt that pays a given rate of interest. In order to raise large amounts of debt, the government must offer higher rates to attract more buyers.

High rates slow the economy down because they reduce the range of profitable projects that investors and firms can pursue. If the interest rate for a given year is 4%, capitalists will take projects that return more than 4%. However, if the interest rate is 8%, fewer projects will be pursued in the economy as a whole. If fewer projects are pursued, GPD grows at a slower rate or not at all, and crucially, fewer people have jobs.

Republicans deny this line of reasoning, arguing that deficits don't matter because Reagan ran large deficits without impacting the economy. The reason that Reagan's deficits didn't matter is that Bush I and Clinton raised taxes, and used those tax revenues to pay off Reagan's debts. Bush's actions were especially courageous. His decision to raise taxes set the groundwork for the 1990's boom, but cost him the 1992 election. While many of Reagan's policies contributed to the strong economic environment of the 1980's, running huge, undisciplined deficits was not one them.

For the record: America's 2003 deficit was a record $374 billion. For 2004, the non-partisan Congressional Budget Office is projecting a deficit of $477 billion.
Back to the Odd Hours main page
© 2004 Odd Hours
Reproduction permitted provided Odd Hours or the author of the quoted post is credited.