Robert Samuelson is looking at the latest projections for the budget and the economy from the Congressional Budget Office (CBO) and struggling with their implications for the deficit. He presents the three reasons that CBO gives for reducing the debt from the projected levels:

1) fear of financial crises;

2) crowding out of investment;

3) we may need to borrow more in the future to cover the costs of a war or natural disaster.

It's worth briefly addressing these concerns, but first we need to note that CBO's track record on the economy in recent years has been nothing short of abysmal. If you want some cheap fun, take a look at CBO's projections for the economy from Janaury of 2008 (Table E-1). Get a load of that 4.8 percent unemployment rate that we are supposed be enjoying right now following three years in which GDP growth averaged 3.3 percent (and that's with no recession in 2008-2009).

CBO's predictive ability had not improved much a year later when the economy was in the middle of the free fall following the collapse of Lehman. Its projections from March of 2009 hugely underestimated the severity of the downturn and projected that the economy would have largely bounced back to full employment by the end of 2011, even if there was no stimulus from the government or extraordinary measures taken by the Federal Reserve Board.

These projections were about as wrong as they could possibly be. We would have done every bit as well finding a drunk person on the street and asking him for his economic forecasts for the next five years.


The point here is not to beat up on CBO. (Actually it is somewhat irksome that the job security of economists who completely mess up is never in jeopardy, unlike the custodians, sales clerks and dishwashers who end up unemployed because of their mistakes.) The point is that CBO's track record in making predictions about the economy has been nothing short of atrocious. The models it used in 2008 and 2009 were basically worthless. Is there any reason to think that it has a much better grasp on the economy in 2013 than it did four or five years ago?

If we look at the specific reasons laid out by Samuelson we can place concerns over the debt in better prespective. The first one, fears of a financial crisis, we should all just give a hearty laugh. What do Samuelson and CBO think they are talking about? They completely missed the last financial crisis, now they consider themselves experts to warn about the next one.

What would this look like and why would it occur? We borrow in dollars. We print dollars. Does anyone think that financial markets will become fearful that we will forget how to print dollars? There is a story that can be told about Zimbabwe-style run-away inflation, but we are so far from this scenario that even Samuelson could not tell it with a straight face.

Going out of order, let's take number 3, we might need to borrow because of a war or natural disaster. Well, this is really just number 1 again in different clothes. Fine, we need to borrow. What is the scenario in which we will not be able to borrow large amounts of money in our own currency? In fact, the best way to ensure that the U.S. can borrow is to ensure that we have a strong economy, which will be best done by building up infrastructure, improving education and keeping our labor force employed and gaining skills. According to CBO's latest estimates, the economy has lost trillions of dollars in potential output because we have not kept people employed and sustained the growth of our capital stock through the downturn.

This gets us to number 2, the old crowding out story. There is undoubtedly some truth to this, but people should understand the logic of the argument.

If we have more debt in circulation, this means that people have more government bonds as a store of wealth. In other words, because we had deficit spending to support the economy today, people will have more wealth in the future. Since people's consumption is in part a function of their wealth, they will consume more in the future because they own more government debt. If people are spending more money on consumption in 2023, then there will be less money for investment. This is how government debt crowds out private investment.

Note that housing wealth and stock wealth also crowd out private investment in the same way. if house prices go up people will consume more, leaving fewer resources for investment. Similarly, if stock prices go up then people will consume more, thereby also crowding out private investment. Higher stock prices do have the offsetting effect of making it easier for firms to issue stock to finance investment. However the experience of the late 1990s bubble was that the effect of stock wealth on consumption is larger than the effect on investment. Consumption rose by more measured as share of GDP in the late 1990s than did investment.

In this sense we can only share Samuelson's and CBO's concern that government debt will crowd out investment insofar as we are also worried about house prices and stock prices being too high. If we are not worried about rising house and stock prices, then we should not be worried about the effect of government debt on investment either.