Deficits don't matter that much

Everyone worries about what health care reform might do to the deficit. Obama insists that any reform not add one dime to the deficit. But, “DO DEFICITS REALLY MATTER THAT MUCH?”

The answer seems simple and obvious—of course deficts matter. However, the truth is that the answer to the question “Do deficits matter?” is neither simple nor obvious. Economists disagree, if not over whether deficits matter at all (most agree that they do at least to some extent) but over whether all deficits matter and just how damaging they are to the national economy. The answer seems to be “economists disagree” and “it depends.”

Reportedly Dick Cheney when he was V.P. didn’t think deficts being run up by the Bush administration mattered. In late 2002, he summoned the Bush administration's economic team to his office to discuss another round of tax cuts to stimulate the economy. Then-Treasury Secretary Paul H. O'Neill pleaded that the government -- already running a $158 billion deficit -- was careering toward a fiscal crisis. But by O'Neill's account of the meeting, Cheney silenced him by saying "Reagan proved deficits don't matter." [Cheney now says he didn’t say what O’neill reported.]

Was Cheney right? Do deficits NOT matter? Here is a quote from an article by Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University.

“If the spending that creates deficits supports your party’s programs, fiscal irresponsibility doesn’t matter. Republicans don’t mind deficit spending if the trade-off is tax cuts and more money for the military. Democrats tolerate deficits when they buy goodies for union workers and allow other increases in domestic outlays.

But can you blame politicians for flipflopping on the issue? Economists—even free market ones—can’t agree on whether deficits matter either.” Interesting article. Read it at: http://www.reason.com/news/show/132625.html

Here is another article from a Harvard economists Laurence Ball and N. Gregory Mankiw that discusses the deficit issue and conditions under which deficits do and do not matter. This quote:

Numerical results suggest that the effects of budget deficits are moderate in size. Moreover, since there are winners as well as losers, it is not obvious that deficits are undesirable overall. These conclusions suggest that popular concerns about budget deficits are overblown, at least when the national debt is at its current U.S. level relative to national income.

The author suggest a way to protect your children should budget defictis matter:

Suppose you are worried about the effects of deficits on your children, and aren’t confident that Bill Clinton and Newt Gingrich will take care of the problem by balancing the budget. You can eliminate your worries simply by saving and leaving a larger bequest to your children, so that they can bear the burden of future taxes without reducing their consumption.

Some economists—advocates of Ricardian equivalence—claim that people do in fact behave this way. If this were true, private behavior would fully offset the effects of public dissaving. Although we doubt that most people are so far-sighted, some people probably do act this way, and anyone could. Deficits give you the chance to consume more at the expense of your children, but they do not require it. Indeed, if you are forward looking and care about your children, deficits can benefit your family. You can insulate yourself from the effects of tax shifting through a larger bequest. And, since you are accumulating more capital than the typical family, you and your children are among the winners from deficit-induced changes in factor prices. That is, you benefit from the higher rates of return that deficits cause.

To read this article go to: http://www.economics.harvard.edu/faculty/mankiw/files/whatdobudgetdeficitsdo.pdf

And here is another article this time from the Federal Reserve Bank of Cleveland

“The empirical evidence and theoretical arguments outlined above suggest that government budget deficits may be unrelated to interest rates or real exchange rates and that they pose no direct threat to our economic well-being. This does not mean, however, that governments' fiscal actions have no bearing on a country's ability to grow and prosper. The relationship is substantially more complicated than generally acknowledged, and depends on the relative size of government and on the types of spending and taxation programs inherent in the budget.”

To read this article go to: http://www.clevelandfed.org/Research/commentary/1993/0615.pdf

And, here is another article from the International Monetary Fund on the deficit issue. It was written by Atish Ghosh, Division Chief and Uma Ramakrishnan, a Senior Economist in the IMF's Policy Development and Review Department.

“A common complaint about economics is that the answer to any question is, "It all depends." It is true that economic theory tells us that whether a deficit is good or bad depends on the factors giving rise to that deficit, but economic theory also tells us what to look for in assessing the desirability of a deficit.

If the deficit reflects an excess of imports over exports, it may be indicative of competitiveness problems, but because the current account deficit also implies an excess of investment over savings, it could equally be pointing to a highly productive, growing economy. If the deficit reflects low savings rather than high investment, it could be caused by reckless fiscal policy or a consumption binge. Or it could reflect perfectly sensible intertemporal trade, perhaps because of a temporary shock or shifting demographics. Without knowing which of these is at play, it makes little sense to talk of a deficit being "good" or "bad": deficits reflect underlying economic trends, which may be desirable or undesirable for a country at a particular point in time.”

To read the article go to: http://imf.org/external/pubs/ft/fandd/2006/12/basics.htm