Wednesday, January 27, 2010

The National Debt: No Apologies Needed

Copyright, The New York Times Company

Government deficits are often criticized because of the purported legacy they leave for the future. At least when it comes to the Obama and late-Bush deficits, this legacy is exaggerated.

By definition, the government runs a deficit when its spending exceeds its taxes.

It typically finances the difference by borrowing. Of course, government debt has to be someday repaid (otherwise no one would agree to lend to the government in the first place), which is why many observers conclude that these deficits leave us worse off in the future. Because our nation will be saddled with government debt in the future, its citizens in the future will either have to spend less, or work harder to pay it off.

This lesson would seem especially applicable during this recession. Over the last two years, the federal government has run unprecedented deficits. The federal debt recently passed $12 trillion, a $3 trillion increase since 2007.

Although we all acknowledge that the government has recently been spending a lot more than it taxes, some of us think that the “legacy” effect has been exaggerated for a couple of reasons.

The first reason is that public dis-saving (that is, public borrowing) is substantially offset by private sector saving. (The second reason I will discuss in next week’s post.)

National savings is the sum of public and private savings, and is the purported channel through which public borrowing would reduce living standards in the future. However, to the degree that private saving offsets public borrowing, public borrowing leaves no such legacy.

The chart below begins to examine the first hypothesis by separately graphing public and private saving as measured by the Bureau of Economic Analysis.

The two series are shown on different vertical axes, but both vertical axes have the same total length: $1,000 per person. Saving by federal, state and local governments are combined into the same “public saving” series. (Aside: In case you’re wondering how total public saving was positive in many years when the federal government ran a deficit, it’s because of saving by state and local governments.)

Thanks in large part to federal government actions, quarterly public savings fell from about zero to negative $400 per person in the first two quarters of the recession, and fell another $400 per person in the first two quarters of 2009.

Interestingly, private saving moved in the opposite direction, increasing more than $200 per person in early 2008, and increasing again about the same amount in early 2009.

People were cutting back their personal spending more than their personal incomes were falling, even while their government let its spending outpace its income.

Indeed, many people are saving because they expect their taxes to go up.

The private saving offset was significant, although perhaps less than one for one.

One interpretation is that national savings would have indeed increased if the government had, say, borrowed $1 trillion less, but the national savings increase would have been much less than $1 trillion.

Alternatively, perhaps national savings would have been low regardless of the amount of government borrowing – after all, we are in a recession that might induce reasonable people (especially the unemployed) to borrow more, or save less. If so, then private sector saving may well have fully offset public borrowing in this recession.

Although former Vice President Richard Cheney is credited with saying “deficits don’t matter,” public policy discussions rarely recognize that private savings will offset public borrowing.

General-theory-Keynesian economists call for public borrowing to combat the “paradox of thrift” (in their view, saving harms a recession economy) but the private offset means that public borrowing only begets more private savings.

Fiscal conservatives who call for tax increases in order to “combat the deficit” also ignore the offset. That’s not to say that government should spend without restraint: Government spending leaves less for private spending. Presidents Obama and Bush do not need to apologize for the federal debt, just the excessive federal spending.

Much credit on this topic is owed to Professor Robert Barro. He has written op-eds like this over the years, such as this one in business week.


DWAnderson said...

Even assuming a 1:1 relationship between private saving and government borrowing, there are still distributional consequences for the future when the debt is being repaid/serviced: forced transfers from taxpayers to debt holders. When the burden on taxpayers becomes too great, there are real problems-- disincentives to work as you have identified in other posts. That is the fundamental concern about the deficits.

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