Uncle Milton in the comments:
To Rob:Maybe I should be like Dick:
Cheney to Treasury: “Deficits don’t matter”
Former Treasury Secretary Paul O’Neill was told “deficits don’t matter” when he warned of a looming fiscal crisis.
O’Neill, fired in a shakeup of Bush’s economic team in December 2002, raised objections to a new round of tax cuts and said the president balked at his more aggressive plan to combat corporate crime after a string of accounting scandals because of opposition from “the corporate crowd,” a key constituency.
O’Neill said he tried to warn Vice President Dick Cheney that growing budget deficits-expected to top $500 billion this fiscal year alone-posed a threat to the economy. Cheney cut him off. “You know, Paul, Reagan proved deficits don’t matter,” he said, according to excerpts. Cheney continued: “We won the midterms (congressional elections). This is our due.” A month later, Cheney told the Treasury secretary he was fired.
Looks like Paul O’Neil was prescient. (and early…)
What Uncle Milton fails to understand is that it’s not the deficit itself that is so important, but more what is causing it.
If you figure out what is causing the deficit, then you can figure out how to deal with it. Bush was running up huge deficits by tax cuts and massive spending on wars. The way to deal with that is to get rid of the tax cuts and stop fighting the wars.
The present deficit is being 90% caused by the present financial crisis. Only 10% of it is being caused by stimulus spending. So there goes the whole rightwing argument that the deficit is due to excess spending.
As long as the financial crisis persists, the deficit will persist. No amount of austerity measures will actually reduce the deficit in the midst of this crisis. All deficit reduction will do is harm citizens and workers and also harm the economy via decreased government spending. So we have to decide what kind of deficit we want to run. Do we want to run a positive deficit by putting people back to work, etc. or do we want to run a negative deficit via decreased tax revenues and a slowed down economy, possibly progressing to Depression and deflation?
With high unemployment, governments will run deficits. It’s inevitable. These unemployment-driven deficits will continue for as long as the high unemployment goes on. Austerity will not drive down these deficits. It will just cause declines in the economy, possibly leading to depressions or even deflation.
Deficit hawks say the main danger from deficits and the reason we need to engage in austerity measures right now is that deficits will lead to increases in interest rates. The present interest rate from the Fed is 0%. However, they are probably referring to interest rates on long-term federal bonds. Low deficits will be rewarded in low interest rates for US government bonds (a good thing), whereas the bond market will punish fiscal irresponsibility by raising interest rates on US government bonds.
Let’s see if there is anything to that. Interest rates on 10 year US bonds are currently 4%, low by historical standards. In 1990, they were at 8%, and that was when we had not only a balanced budget but a budget surplus, which George Bush promptly blew. So, looking 10 years out, the bond market is not worried at all about US deficits and is not punishing the government for its deficits by higher interest rates. So the theory is not working. There is no risk of high interest rates at the moment. The deficit hawks’ argument is revealed to be a gigantic lie.
Another argument is that bond markets can change at any minute. We have to reduce deficits now because the bond market could change at any time. But this makes no sense. If the bond markets are irrational, all arguments towards rationality along the lines that the bond markets punish irresponsibility and reward austerity vanish. We are not dealing with a rational market here. And if the market is irrational, it makes sense to borrow now as long as it is offering good deals (low interest rates so the state can borrow cheaply).
Another argument is that deficits lead to the risk of inflation.
There is little to no inflation in the US at the moment, so this argument appears to be hogwash as far as right now anyway. Core CPI inflation is running at 1%. The opposite of inflation, deflation, is actually the worry here.