By Jason Furman and Lawrence H. Summers
Peterson Institute of International Economics
In recent months the debate over the future of fiscal policy has intensified. For example, Olivier Blanchard, in his presidential address
to the American Economic Association this year, highlighted the implications of the empirical fact of sustained low real interest rates for fiscal policy, and others have debated the purported changes in the nature of economic theory itself—most notably modern monetary theory (MMT). In January we made our own contribution
to the fiscal policy debate in Foreign Affairs. We offer here our current perspectives on a number of issues that have emerged as most salient in the months of discussion since then.
1. IS THE POLITICAL SYSTEM SO BIASED TOWARDS DEFICIT INCREASES THAT ECONOMISTS HAVE A RESPONSIBILITY TO OVEREMPHASIZE THE COSTS OF DEFICITS?
Sometimes the political system is biased towards generating inefficiently large deficits, but other times it is biased in the opposite manner—the role of economists is to share the often nuanced economic reality.
A number of critics of our arguments in Foreign Affairs appear to believe that the political system naturally tends to increase deficits too much out of short-run expediency and in turn believe it is the responsibility of economists to perpetuate the moral principle that deficits are very, very bad. For example, the Washington Post’s Robert Samuelson, whose principled advocacy and analysis we greatly admire, argued
“If Washington feared debt, Congress would long ago have tamed budget deficits…. What both Democrats and Republicans actually fear are the highly unpopular steps—spending cuts or tax increases—they might have to take to reduce or eliminate the deficits, which are huge.”
Samuelson is indeed right that the political system can be biased towards greater deficits. But the opposite is often the case as well. Among the largest economic policy errors of the last decade was that the fiscal stimulus was too small in the wake of the Great Recession—that is, deficits were too small, not too large. This is not just an isolated example. In the 1960s and 1970s one of the top concerns of economists at places like the Brookings Institution was “fiscal drag,” or the fact that the system would generate too much deficit reduction. The deficit reduction in the late 1990s was probably excessive, especially in light of the license it gave for unproductive tax cuts. Germany is one of many countries that has also shown that politicians can generate excessive fiscal prudence. Japan has done the same at many points in the 20 years after its financial bubble burst in1989—the most recent example being the self-induced recession caused by raising its consumption tax in 2014.
With interest rates so low that they could limit central banks’ ability to respond in a downturn everywhere in the industrial world, the dangers posed by anti-deficit dogma in the next recession could be enormous.
As a general rule, we think the role of economists is to analyze the economy and not to lean one way or the other to counteract some presumed bias of politicians. The fact that politicians are not always biased towards making deficits too large, and may become more or less biased over time, argues for providing an accurate assessment of the economic realities, not guessing how that assessment should be skewed to counteract perceived political biases.
2. DO THE CHANGING ECONOMICS OF DEFICITS MEAN THAT ANYTHING GOES AND WE DO NOT NEED TO PAY ANY ATTENTION TO FISCAL CONSTRAINTS, AS SOME HAVE INFERRED FROM MODERN MONETARY THEORY (MMT)?
No. The costs and benefits of deficits have changed, but we still need a limiting principle in order to conduct fiscal policy.
The economics of deficits have indeed changed in profound ways. Anyone repeating unchanged talking points and policy nostrums over the last several decades has clearly missed out on the fact that real interest rates have fallen from nearly 4 percent in 2000 to around 1 percent today despite the fact that the debt has exploded. This is the result of what one of us has termed secular stagnation
and appears to be due to a combination of demographic changes, rising inequality, and declines in the cost of and taste for capital goods.
The idea that we need deficit reduction to keep interest rates down and thus encourage borrowing and investment may have made sense years ago, but it would be an absurd diagnosis of today’s economic problems. In fact, if we had actually kept the budget in balance after 2001, the result, according to research
coauthored by one of us, would have been even lower underlying real interest rates, making it likely that the Federal Reserve would have still kept nominal rates at zero—and even then we would not have adequate demand.
When interest rates are less than the growth rate, then the government can perpetually run primary deficits (that is, a deficit excluding interest) and still have debt falling as a share of the economy. It cannot, however, run unlimited primarydeficits without the debt rising substantially as a share of the economy.
Fiscal constraints are real. Even if one accepted the MMT idea that inflation is the only constraint on government spending, there is still some constraint on what government can afford. As long as we eventually face a budget constraint, then the government needs to prioritize among the many worthy, and some not so worthy, claims on scarce resources. Without this limit, how can we say no to any sympathetic group or force tax increases on any except the most reviled?
div>In our Foreign Affairs article we proposed that the political system should adopt a “do no harm” approach, paying for new proposals but not necessarily making it an urgent priority to do any more than that. Adopting this principle would have the benefit of requiring policymakers to think harder about whether to adopt the next seemingly popular tax credit or spending program. Many ideas that seem appealing judged against an unspecified future cost are less appealing when you make their costs explicit today.
div>To the degree the imbalance between revenue and spending in Social Security and Medicare is eventually reduced—much of it through higher revenue—those savings should not be available to pay for new spending but instead count towards the existing spending we have already promised. This would make the reform effort net deficit reducing compared with the standard projections from the Congressional Budget Office and others that are widely cited. The result, based on current projections, would be to stabilize the debt as a share of the economy at a reasonable level.