mainly macro: Do Trump’s deficits matter?

mainly macro: Do Trump’s deficits matter?


Should Democrats
complain about the large deficits that Trump and the Republicans are
creating? Or is this playing into the Republican narrative that made
the stimulus in 2009 inadequate and gave us austerity from then
onwards?

The answer that
mainstream economics gives is straightforward. In a recession when
interest rates have hit their lower bound [1] you do not worry about
the deficit and you ignore those that do worry. Deficits should be
whatever size is required to enable the economy to recover. Enough
stimulus so that central banks feel they need to raise interest rates
above their lower bound. Politicians failed to follow that advice
during the last recession.

In contrast, when
the economy is not in a recession, and interest rates are perfectly
able to control aggregate demand, then deficits at a level where
government debt starts rising may well be a problem. For various
reasons, not least the chance of a recession, it is best to have
deficits at a level which very gradually reduces the ratio of
government debt to GDP, unless you have a good reason for doing
otherwise.

There are many
reasons why, outside of a recession, deficits that, if sustained,
would steadily increase the debt to GDP ratio may be bad for the
economy, but let me give the most obvious here. For a given level of
government spending, interest on debt has to come out of taxes. The
higher the debt, the higher the taxes. That is a problem because high
taxes discourage people from working, and it is also unfair from an
intergenerational point of view.

This last point is
obvious if you think about it. The current generation could abolish
taxes and pay for all spending, including any interest on debt, by
borrowing more. That cannot go on forever, so at some point taxes
have to rise again. A whole generation has avoided paying taxes, but
at the cost of future generations paying even more.

As a result, unless
there is a very good reason like a recession [2], a responsible
government will not plan to sustain a deficit over time that raises
the debt to GDP ratio. The problem though is that it is very tempting
for a government not to be responsible. The current US government,
which is essentially a plutocracy, wants above all else to cut taxes
for the very wealthy, and if they do it without at the same time
raising taxes on other people but instead by running a deficit they
think they can get away with it. Democrats have every reason to say
that is irresponsible, although of course the main thing they should
focus on is that the last people who need a tax cut are the very
rich.

Unfortunately being
responsible can seem rather dull and boring, so it may be tempting to
hype things up a bit by predicting some disaster that will come from
rising deficits. That is not a good place to go, because you are
crying wolf. Large deficits are like overeating. Do it once or twice
and you will survive. Do it every day and you will die young. The
only difference from overeating is that you do not die young, but
your children do.

So much for
mainstream economics. What about MMT, which is often characterised as
implying that deficits do not matter? That is an incorrect
characterisation: what MMT actually says is that inflation should
determine what the deficit should be. If inflation looks like staying
below target you can and should have a larger deficit, and vice
versa. The reason they say that is that they think the central bank,
in changing interest rates to control inflation, is wasting its time,
because they believe rates do not have a predictable impact on demand
and inflation. If that were true, then even mainstream economists
would agree that the deficit should be at whatever level keeps
inflation at target. The difference between MMT and the mainstream is
whether the central bank is or is not wasting its time.

In an important
sense, whichever perspective you take, thinking about stabilisation
policy or long run deficits can just muddy the waters when it comes to the Republican tax cuts. The reason
that Republicans mainly fund tax cuts for the very wealthy by
borrowing is that it appears this is not costing anyone anything. If
nobody’s taxes are going up, the argument goes, why should we mind
too much if the richer get even richer. The key point to get across
is this. There are two possibilities. The first is that if it is
possible to permanently cut some taxes forever without raising others or cutting spending, why should the tax cut
not go to those who need it rather than those who don’t. The second more likely possibility is that it is not sustainable, in which case at some
point tax paid by ordinary people will go up or 
spending on ordinary people will be cut to pay for tax cuts to
the very rich. Either way, ordinary people are losing out. To focus on deficits or inflation just detracts from this
basic truth.

[1] The lower bound
is either where the central bank thinks it is or the point that
interest rate cuts become an unpredictable and therefore ineffective
instrument.

[2] A natural rather
than man made disaster might be another good reason to run deficits.
Public investment on high return infrastructure is another.



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