February 19, 2020
To my knowledge, he hasn’t said anything like that, but Buttigieg did say that he doesn’t accept the “fashionable” view that current deficits are not a problem. When he made this comment, many progressives denounced him for supporting deficit reducing policies that will slow growth and raise unemployment. Since most plans for deficit reduction also involve cuts to social programs (it’s compromise land), this is likely to mean additional hardships for the poor and elderly who are the primary beneficiaries of these programs.
The response of many centrists to these attacks (e.g. here) was to say that Buttigieg was just using campaign rhetoric, he doesn’t really mean it. Guessing what is in any politician’s head is always difficult, but it is especially hard with someone like Buttigieg, with a very short track record and few clear ideological convictions.
But whatever may be in Buttigieg’s head, we can certainly look at his words. He didn’t just indicate he disagreed with a view on deficits that has been largely embraced by the mainstream of the economics profession, he implied that this view was frivolous – a fashion that could change at any time.
This is more than a little annoying for those of us who have spent a lot of time in budget debates, especially in the dozen years since the collapse of the housing bubble gave us the Great Recession. The view that large deficits, like the one the country is now running, are not a problem came about as a result of an analysis of the evidence.
Ever since the collapse of the housing bubble, the economy has suffered from a persistent shortfall in demand. The loss of demand from the collapse of the bubble was enormous. At its peak in 2005, housing investment was 6.7 percent of GDP. In the most recent quarter it was just 3.8 percent of GDP. The difference of 2.9 percentage points of GDP translates into more than $600 billion in lost annual demand.
In addition, there was a falloff in consumption demand associated with the collapse of the housing bubble. The ephemeral wealth created by the housing bubble led to a surge in consumption spending, as people spent based on the newly generated wealth in their homes. At the peak in 2005, households consumed 97.5 percent of their disposable income. When the bubble burst and the housing wealth disappeared, so did the bubble driven consumption. In the most recent quarter, households were consuming just 92.3 percent of their disposable income. The difference in consumption shares translates into more than $800 billion annually of lost demand in today’s economy.
If we add the loss in annual demand from the falloff in housing investment and reduced consumption, it comes to more than $1,400 billion. As we have painfully learned since the Great Recession, there is no easy mechanism to replace this lost demand. The view formerly held by many economists, that the Fed could just lower interest rates and bring the economy back to full employment, has been shown to be clearly wrong. Even with the Fed’s interest rate at zero for seven years, the economy still did not rebound to anything like full employment.
This is the context in which much of the mainstream of the economics profession came to embrace the view that large budget deficits could be sustained for long periods of time. Given a persistent shortfall in demand in the economy (a.k.a. “secular stagnation”), there is no other sector that could provide the boost to growth necessary to bring the economy to full employment.
Rather than being a liability, large deficits are needed to lower the unemployment rate. And, low unemployment rates are especially important to African Americans, Hispanics and other disadvantaged groups in the labor market, since they disproportionately are the job gainers as the labor market tightens. In a tight labor market, employers have no choice but to employ people who would otherwise be the victims of discrimination. With the unemployment rate now well under 4.0 percent, there are accounts of employers even reaching out to people with criminal records who they might otherwise never consider employing.
Tight labor markets also give workers at the middle and bottom of the wage distribution the bargaining power needed to achieve wage gains. After seeing declines in real wages in the years immediately following the Great Recession, workers at the middle and bottom of the wage distribution have been seeing real gains of more than 1.0 percent annually over the last five years.
If we had smaller budget deficits, we would have seen less demand in the economy and less growth. This would have meant fewer jobs, higher unemployment, and less bargaining power for workers. That is the Pete Buttigieg world. He may not know this or he may not care, but we should be clear, this is what his call for lower budget deficits means.
The Story of Evil Deficits I
The conventional story of the evils of budget deficits is that they lead to higher interest rates, which then crowd out investment. Less investment (both public and private) is bad news because it means that productivity growth will be slower, leaving us poorer in the future than we would otherwise be.
This story clearly does not fit the current situation. The interest rate on 10-year Treasury bonds is just 1.6 percent. That compares to interest rates of 4.0-5.0 percent back in the late 1990s when we were running budget surpluses. With interest rates at historically low levels for the last decade, it is pretty hard to make the case that the deficit has been crowding out investment.
The conventional story would also hold that large deficits could lead to inflation, if the Fed failed to act by pushing up interest rates. This story also does not fit with the data. The inflation rate, as measured by the Consumer Price Index was 2.5 percent over the last year, but this reflects jumps in energy prices last fall. The inflation rate in the core personal consumption expenditure deflator, the rate targeted by the Federal Reserve Board, has been just 1.6 percent over the last year.
This is well below the Fed’s 2.0 percent target, which is meant to be an average. That means that the Fed would like to see the inflation rate occasionally be somewhat above 2.0 percent in order to balance out the periods of below 2.0 percent inflation. From the Fed’s standpoint, the problem has been that the inflation rate has been too low, not too high.
In short, we are not seeing either of the short-term problems usually attributed to large budget deficits. Interest rates are at historically low levels, so we can’t tell a story about deficits crowding out investment, and inflation has been consistently below its targeted rate, so there is no basis for complaints about the deficits causing inflation. So, if Buttigieg has a story about deficits doing harm to the economy, it is not one of the conventional stories economists tell.
The Story of Evil Deficits II
The other story often told about the budget deficit is that it will be a burden on our children, since they will have to pay interest on the debt. The story goes that our current publicly held debt of $16.9 trillion (79.2 percent of GDP) will impose an enormous burden as future generations struggle to pay it off. There are three points to be made on this.
First, these interest payments are an intragenerational issue, not an inter-generational issue. The debt is overwhelmingly held domestically. This means that the interest payments will be made by some of our children to the children of other people. In twenty or thirty years, ordinary workers may be paying taxes to pay the interest on the bonds held by the children of Bill Gates and Jeff Bezos. That could be a problem, but it is one that is easily solved by taxing the children of Bill Gates and Jeff Bezos. This is just saying that inequality can be a problem, which is obviously true, and if Bill Gates and Jeff Bezos’ kids hold lots of government bonds, the interest they get on those bonds could be part of the problem.
The second point is, that in spite of the large debt, the interest burden is relatively low, due to the extraordinarily low interest rates we have seen in recent years. The latest projections from the Congressional Budget Office show that interest payments, net of remittances from the Federal Reserve Board, will be just 1.4 percent of GDP in 2020. This compares to payments of more than 3.0 percent of GDP in the early and mid-1990s. It is pretty hard to get too upset about a burden that is less than half as large as what we faced three decades ago. And, that burden did not prevent the 1990s from being a relatively prosperous decade.
The final reason the debt interest burden argument richly deserves our ridicule is that it is very selective in choosing what burdens to consider and what burdens to ignore. Direct spending is only one mechanism the government uses to pay for things it wants done. It also gives out patent and copyright monopolies. These government-granted monopolies can be thought of as private taxes that the government allows companies to collect from the public in exchange for innovation and creative work.
The amount of money at stake in the rents from patent and copyright monopolies swamps payments of interest on the debt. In the case of prescription drugs alone the rents are going to be in the neighborhood of $400 billion in 2020 (1.8 percent of GDP). If we add in the rents from these monopolies in medical equipment, computer software, recorded music, movies, and video games, we are almost certainly over $1 trillion, or close 5.0 percent of GDP.
It doesn’t make any sense to hyperventilate about an interest burden of 1.3 percent of GDP, while ignoring rents from patent and copyright monopolies that are more than three times as large. If Buttigieg wants to make a big deal about the interest burden from the debt, then it is clearly not due to any objective reality. He is either appealing to prejudices or simply reflecting his own ignorance of budget and economic realities.
Yes, People Who Care About Economic Policy Should be Offended by Buttigieg’s Budget Comments
Only Buttigieg knows his actual motives for dismissing the lack of concern about budget deficits as a “fashion.” However, this lack of concern is based on hard data and clear theoretical thinking. Whatever reason Buttigieg has for saying that we should be concerned about budget deficits, those of us who have done our homework have every reason to be angry at Buttigieg, just as serious climate scientists are justified in their anger at the climate denialists.