Somewhere In Between No Debt and Unsustainable Debt Is “Just Right”
June 3rd, 2010 . by economistmom
If you hear me on NPR and NPR.org this week, you may think I sound schizophrenic. On a story about private donations to pay down the national debt, I remarked that such acts are honorable but futile, and even if we theoretically could pay off the debt completely today, it would not be wise economically nor fair intergenerationally. On Morning Edition this morning, you may have heard me say that the economy is now recovering, and it’s time we come up with “a plan to pay our bills.”
I am not confused nor being hypocritical. Note that I called for “a plan” to pay our bills (reduce the deficit), not the actual paying of the bills now. That’s because while continued deficit spending may be justified for the recovering-but-still-weak economy, that doesn’t mean that any deficit spending at any level is justified. And honestly, without some recognition of budget constraints, experience tells us that we just aren’t good at prioritizing and putting scarce resources to their most valuable uses.
To be a “deficit hawk” right now doesn’t mean fighting to get the deficit down to zero (let alone the debt down to zero). It means fighting to make sure that any deficit spending is worth its cost. The BP disaster should be another reminder that we have better ways that we have to or would choose to spend public money, so we cannot afford to not prioritize and behave as if there are no constraints.
There is a “just right” level of deficit spending and a “just right” mix of things for which we’re willing to deficit spend, and right now I believe it’s somewhere between zero and (not necessarily the level we’re at but) the unsustainable path we appear to be on.
Diane,
So what do you say to Paul Krugman to convince him to adopt your Goldilocks Plan?
A big problem with the push to come up with a plan to reduce deficit spending is that the Keynesian theoretical framework doesn’t really support any reason for alarm about deficit spending. Sure, Keynes himself would be aghast about current day policies. However, the fusillades he launched against the neoclassical economics framework have left the economics profession unable to counter the likes of Paul Krugman who say there is nothing to worry about deficit spending.
In the Keynesian world, Aggregate Demand stimulus is the hammer that makes every recession look like a nail. Slack in the economy is viewed as a market “failure” that only activist government policies can rectify. What element of the Keynesian framework could identify a wrong-headed or excessive government stimulus plan?
Bromides about the dangers of deficit spending sound downright Pollyannish when matched against the slick sales pitches of Krugman to spend our way into prosperity.
VAT Brat:
The answer to your question is — potential output. That provides the limiting principle you are looking for. Furthermore, this isn’t just a theoretical concept, CBO computes current and future values (at quarterly rates).
Paul,
What does the CBO model say about the relationships between “potential output,” the level of government spending and the levels of tax revenues?
BTW, I don’t think most economists view the CBO Model as the Oracle of Delphi regarding economic theory.
Potential GDP is a “Keynesian” solution to the Keynesian question you posed. CBO uses inflation data, unemployment data, and certain long-term relationships in other data to compute levels for factors of production consistent with stable inflation. It then uses those levels to compute potential GDP.
Government spending and tax revenue are components of aggregate demand, they influence the level of output we observe, but I don’t think they play any role (at least any reasonably direct role) in computing potential output.
Here is a nice discussion:
http://www.cbo.gov/doc.cfm?index=5191&zzz=23756
Paul,
The paper you cited only supports the points I was making. Krugman and the Keynesian enthusiasts believe we’re in an Okun Gap, and deficit spending should continue. Nowhere does the paper you cite mention any harm to GDP growth from “excessive” deficit spending.