The federal budget deficit was just shy of $1 trillion for fiscal year 2019, prompting the usual hand-wringing about the long-term fiscal health of the U.S. These concerns are overblown. For now, the deficit is reducing the risk of an economic crisis, not increasing it.
To be sure, the U.S. will have to cut the deficit eventually. And Americans should hope that time comes sooner rather than later, because it will mean an end to this era of insufficient demand, low long-term interest rates and the persistent threat of recession.
That said, it’s also important to note that the deficit is actually lower than expected. In January 2017, before Donald Trump took office and the Republican Party exploded the deficit with a program of tax cuts and spending increases, the Congressional Budget Office expected the national debt to reach 95% of gross domestic product by 2030. In its latest estimate this past June, the CBO estimated that the budget deficit would be 93% of GDP by 2030.
What happened?
First, GDP growth has been more robust than the CBO projected, in part due to the fiscal stimulus that the near-term deficits produced. More important, the CBO lowered its estimate of the interest rate on U.S. debt, consistent with falling interest rates in America and around the world.
Cutting the deficit would … make a recession more likely.
The CBO’s frightening projections are built on a host of conservative assumptions, as they should be. They are also based on a model of the world in which the primary limit on growth is the availability of savings to fund new investment. As the government spends more, these models suggest, savings will be depleted, interest rates will rise and the economy will slow.
But the world today is awash in savings – in particular, savings looking for a safe home. There are few safer investments than U.S. Treasury bonds, so the government pays a very low interest rate.
Some say those rates are too low. At the start of the Great Recession in 2007, the Federal Reserve’s main interest rate was 5.25%. By December 2008, it was effectively zero, and that still wasn’t enough to arrest the fall.
Today the federal funds rate is 2%. That leaves almost no room to handle even a normal recession, let alone another crisis. That leads to suggestions that the Fed raise interest rates now, so that it can then cut them if a crisis strikes.
Doing so would be a mistake. It would reduce economic growth immediately and risk a crisis.
Which brings us to the final lesson about the deficit. Some commentators worry that by running large budget deficits now, the U.S. is giving up its future ability to boost the economy in a downturn.
But this argument suffers from the same fallacy as the one in favor of raising interest rates now so they can be lowered later. Cutting the deficit would slow economic growth and make a recession more likely. Indeed, if the U.S. does avoid a recession in 2020, it will be in part due to the boost provided by deficit-financed tax cuts and spending over the past three years.
The global economy is in an unusual state. The usual strategy of countercyclical fiscal policy and conservative monetary policy doesn’t apply. Hopefully, this state won’t last forever. Increases in growth in Africa and Asia, or a technological revolution in the U.S., may increase the demand for investment. Savings will once again become scarce.
At that point, the U.S. government would have to make some hard choices about how to get its house in order or risk sharply rising interest rates. For now, however, deficit-financed stimulus is making the economic environment safer, not more dangerous.
Karl W. Smith is a Bloomberg Opinion columnist.
