Budget Deficits: Only a Minor Crisis
My wife was watching C-Span on television a few weeks ago, and one of the chief economists at the Congressional Budget Office was talking about budget deficits. He said they were a major crisis, but people were being misled about their severity because most of the usual indicators -- such as prices of financial assets, inflation and real economic activity -- were giving off reasonably rosy, but false, signals.</br></br>My wife was skeptical. Couldn't it be that all of these indicators were right, and that the budget deficit was just not a big deal? Anyhow, where did this CBO economist get his information if not from all the data that gave different answers? Probably he was just a slave of some outmoded economic theory that predicted effects that hadn't shown up. Moreover, didn't David Ricardo have a theory that said that budget deficits were roughly equivalent to taxation, and didn't this theory conform pretty well with the evidence that this CBO fellow said we should ignore? I agreed with my wife and assured her that a growing number of economists were coming to that viewpoint, but that we still numbered only 22% of the membership of the American Economic Association.</br></br>I admit that federal budget deficits since 1984 have been higher than I would have predicted, based on a model that views deficits as a device to smooth out tax collections over time. For example, the budget deficit for the current fiscal year, when measured as the change in the privately held public debt, is about $210 billion. I would have predicted a deficit of between $110 billion and $170 billion: $60 billion associated with the federal net interest payments of $130 billion, $50 billion for the persistent failure to reach full employment, and as much as $60 billion to offset the surplus of the state and local sector. That leaves an excess deficit of $40 billion to $100 billion. Smaller but still significantly positive values apply for 1984 and 1985.</br></br>I see three possible explanations for the large budget deficits of recent years. First, they may simply be mistakes. In this case they are also good experiments, which economists can use to figure out the effects of budget deficits on the economy.</br></br>Second, people may believe that the "Reagan Revolution" portends a declining share of federal spending in gross national product. In that case current spending is temporarily high, and it makes sense to run a budget deficit rather than to enact a temporary increase in tax rates. But I find this forecast of declining federal spending doubtful, and there is no sign of it yet in the data.