Nearly three years ago, Erksine Bowles and Alan Simpson—the two chairs of a presidential commission on deficit reduction—warned that the United States was on the verge of a terrible debt crisis:
“This problem is going to happen long before my grandchildren grow up,” said Mr. Bowles, who was White House chief of staff during the Clinton administration. “This is a problem we are going to have to face up to it maybe two years, maybe a little less, maybe a little more.”
As far as predictions go, this one was terrible. Not only have we not seen a debt crisis—markets continue to have faith in our ability to pay our obligations—but our deficits have tumbled to five year lows. According to the latest report from the Congressional Budget Office, the deficit is set to fall to $514 billion for the current year.
But before you rejoice, you should consider this other tidbit: “The CBO sees the long-term deficit picture worsening by about $100 billion a year through the end of the decade because of slower growth in the economy over the coming decade than it had previously predicted.”
There's a reason for this.
We’re still in a demand-starved economy. There aren’t enough jobs for the people who want them, and a good chunk of our declining unemployment rate has more to do with people leaving the labor force than it does with a stronger labor market. And the fiscal retrenchment of the last few years—from the fiscal cliff deal to the sequester—isn’t helping. Indeed, at various points over the last year, both the Federal Reserve and independent economists have worried that we’re undermining our recovery with rapid deficit reduction.
This, obviously, doesn’t jibe with the folk economics of the public. To most people, politicians and voters alike, deficits are self-evidently bad—when you spend more money than you take in, you have a problem. This might be true of households and individuals—and even then, it’s not as true as it seems—but the dynamic is different for governments.
In this economy, at this time, the federal budget deficit is something of a lagging indicator. Pace Republicans, who tend to blame the deficit for a bad economy, it’s more a product of conditions, not the cause. And the sky high deficits of Obama’s first few years were the result of an awful recession and slow recovery—mass unemployment leads to low tax revenues and greater spending on efforts to mitigate the pain.
The right way to get the deficit to fall is to improve the economy, and with depressed demand—as evidenced by the structure of consumer spending—the best way to do that is with government spending programs (like direct aid to states, or new infrastructure building) and expansionary monetary policy (like setting a higher inflation target). When people have jobs, they spend, and when they spend, they generate new economic activity, which raises government revenues from tax collection. At the same time, lower joblessness means fewer people using food stamps, unemployment insurance, and other safety net measures. In short order, you have a smaller deficit.
What we’re doing runs in the opposite direction. By cutting all sorts of spending—including benefits for the unemployed and the poor—we’re taking money out of the economy. And in the absence of that government spending, there’s not much else—businesses still aren’t hiring like they should, and states and localities are still making cuts and responding to reduced revenue.
In the short term, this gets us a smaller deficit, but in the longer-term—reflecting our economic fundamentals—it results in slower growth. Hence, the CBO’s projection for the next decade.
Of course, politicians will celebrate this new, lower deficit—I expect to hear about it in President Obama’s next speech—but the truth is that it’s bad news for an economy that has had more than enough of it.
