Dean Baker: "the country really has no near-term or even mid-term deficit problem." [View All]

[Better Believe It]

The Deficit Commission’s Parallel Universe
Dean Baker
Dean Baker is an American macroeconomist and co-founder of the Center for Economic and Policy Research, with Mark Weisbrot. He previously was a senior economist at the Economic Policy Institute and an assistant professor of economics at Bucknell University. He has a Ph.D. in economics from the University of Michigan.
November 11, 2010

First, the current deficit should not even be viewed as a problem. Yes, a deficit of $1.4 trillion is big, but this is a direct result of the loss of demand stemming from the collapse of an $8 trillion housing bubble. This bubble was driving the economy until its collapse. There were two channels through which the bubble generated demand in the economy: bubble-inflated house prices led to a boom in construction, bubble-inflated wealth led consumers to increase their spending, pushing saving rates to almost zero.

This demand has disappeared now that the bubble has deflated. The economy has lost more than $600 billion in annual construction demand as builders cut back in response to an enormous over-supply of both residential and non-residential property. Similarly, consumption has plummeted. This left an enormous gap in demand that, at least in the near-term, can only be filled by the government. If the government were to spend less—say it instantly balanced its budget—the primary result would be a further decline in demand and more job loss.

The failure to understand current deficits also leads to a misunderstanding of the debt burden. Simpson and Bowles raise fears of an exploding debt reaching 90 percent of GDP by the end of the decade. They have raised the prospect of a crushing interest burden facing future generations of taxpayers.

But there is no real basis for this concern. There is no reason that the Fed can’t just buy this debt (as it is largely doing) and hold it indefinitely. If the Fed holds the debt, there is no interest burden for future taxpayers. The Fed refunds its interest earnings to the Treasury every year. Last year the Fed refunded almost $80 billion in interest to the Treasury, nearly 40 percent of the country’s net interest burden. And the Fed has other tools to ensure that the expansion of the monetary base required to purchase the debt does not lead to inflation.

This means that the country really has no near-term or even mid-term deficit problem. The current deficit is a positive. In fact, if it were larger we would have more jobs and growth. Furthermore, there is no reason that the debt being accumulated at present should pose any interest burden on future generations. In this vein, it is worth noting that Japan’s central bank holds debt amounting to almost 100 percent of that country’s GDP. As a result, Japan’s interest burden is considerably smaller than the United States’s, even though Japan’s debt is almost four times as large relative to the size of its economy.

Read the full article at:

http://www.bostonreview.net/BR35.6/baker.php