Paul Krugman Thinks The Debt Doesn’t Matter?

Paul Krugman is a Nobel Prize Winning economist. That means, he should know better than to essentially say that the deficit doesn’t matter. In fact, I believe he does know better and is writing things he doesn’t really believe about economics for politics’ sake.

But, Paul, Paul, Paul — such a tangled web we weave, when we practice to deceive:

So new budget projections show a cumulative deficit of $9 trillion over the next decade. According to many commentators, that’s a terrifying number, requiring drastic action — in particular, of course, canceling efforts to boost the economy and calling off health care reform.

The truth is more complicated and less frightening. Right now deficits are actually helping the economy. In fact, deficits here and in other major economies saved the world from a much deeper slump. The longer-term outlook is worrying, but it’s not catastrophic.

…There are two main reasons for the surge in red ink. First, the recession has led both to a sharp drop in tax receipts and to increased spending on unemployment insurance and other safety-net programs. Second, there have been large outlays on financial rescues. These are counted as part of the deficit, although the government is acquiring assets in the process and will eventually get at least part of its money back.

What this tells us is that right now it’s good to run a deficit. Consider what would have happened if the U.S. government and its counterparts around the world had tried to balance their budgets as they did in the early 1930s. It’s a scary thought. If governments had raised taxes or slashed spending in the face of the slump, if they had refused to rescue distressed financial institutions, we could all too easily have seen a full replay of the Great Depression.

As I said, deficits saved the world.

In fact, we would be better off if governments were willing to run even larger deficits over the next year or two. The official White House forecast shows a nation stuck in purgatory for a prolonged period, with high unemployment persisting for years. If that’s at all correct — and I fear that it will be — we should be doing more, not less, to support the economy.

But what about all that debt we’re incurring? That’s a bad thing, but it’s important to have some perspective. Economists normally assess the sustainability of debt by looking at the ratio of debt to G.D.P. And while $9 trillion is a huge sum, we also have a huge economy, which means that things aren’t as scary as you might think.

Here’s one way to look at it: We’re looking at a rise in the debt/G.D.P. ratio of about 40 percentage points. The real interest on that additional debt (you want to subtract off inflation) will probably be around 1 percent of G.D.P., or 5 percent of federal revenue. That doesn’t sound like an overwhelming burden.

Now, this assumes that the U.S. government’s credit will remain good so that it’s able to borrow at relatively low interest rates. So far, that’s still true. Despite the prospect of big deficits, the government is able to borrow money long term at an interest rate of less than 3.5 percent, which is low by historical standards. People making bets with real money don’t seem to be worried about U.S. solvency.

The numbers tell you why. According to the White House projections, by 2019, net federal debt will be around 70 percent of G.D.P. That’s not good, but it’s within a range that has historically proved manageable for advanced countries, even those with relatively weak governments. In the early 1990s, Belgium — which is deeply divided along linguistic lines — had a net debt of 118 percent of G.D.P., while Italy — which is, well, Italy — had a net debt of 114 percent of G.D.P. Neither faced a financial crisis.

So is there anything to worry about? Yes, but the dangers are political, not economic.

I hate to excerpt so much of the column, but it was necessary to give Krugman’s argument its full due.

First off, the claim that we had to make massive expenditures to stave off the next Great Depression is often made, but is seldom supported by the facts. If you look at the raw numbers, this recession is probably only slightly worse than the one we faced in the early eighties. Now, you can argue that it could have been far worse without the enormous amount of government intervention, but that seems to be a dubious assertion. For example, the “Congressional Budget Office estimated that the recession would end in the ‘second half of 2009’ even if Obama did nothing.” So, we’re going to spend 1.2 trillion on a stimulus and trillions more propping up banks, GM, etc., and all we’re going to get is a recession that’s going to end about the same time it would have probably ended had we done nothing at all.

Looking at the long-term projections, Krugman is making a lot of extremely iffy assumptions. Just because pissant countries like Belgium and Italy have managed to survive for a few decades without a major crisis during a relatively stable period, doesn’t mean that the world’s largest economy can necessarily do the same thing, even as it becomes clearer and clearer that we can’t pay off our debts.

What happens as we run progressively larger and larger deficits? What happens if there is a major economic collapse in Europe, driven by the demographic timebomb that’s going off in slow motion over there? What if Al-Qaeda were to wipe out multiple American cities with nuclear bombs? What if climbing debts from multiple nations cause credit to dry up and interest rates to soar? What if China engages in “economic warfare” against us and refuses to loan us any more money?

“Oh, but, John, those are fantastic scenarios! Those things are unlikely.” Here’s the problem: Historically, great nations tend to fall when they get rigid, fragile, overextended. Then some major event finally happens that overwhelms their ability to respond. Economic resilience is extremely important for a powerful nation like ours. For example, just think back to WWII and how much trouble we’d have been in if we hadn’t had the money and manufacturing capacity to wage war. To simply presume that we won’t face any unexpected major challenges in the future is very foolish.

Last but not least, Krugman glossed over the biggest problem: our political system makes it extremely difficult to get spending under control. Democrats are all for spending as much as possible on as many things as possible, with the exception of intelligence and defense. Republicans are in favor of spending less, but even they’re not in favor of making significant cuts. In other words, spending can go up a little or a lot each year, but there is no party that has the political will to hold the line for years at a time or make cuts. In other words, we have a system in which spending only goes up, not down, and it’s going up by increasingly ridiculous margins. This may not bother Krugman, who apparently assumes that some day, somehow, some adult will find a way to fix the problem, but it does worry other people — and it should.

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