Therefore, I'm not arguing that deficits are always bad, or making any sort of statement on the current deficit. I merely point out that it is a tradeoff -- anything you borrow today must be paid tomorrow, and that you must understand the costs and benefits. So, the real question must be, do the economic gains made by deficit spending outweight the costs of economic contraction whenever we have to start paying down the debt?
Yes, I agree. The excess debt incurred in lean years must be repaid during economic recovery. I think the confidence we can have that the debt can be repaid is a function of just how the economy faltered and why the deficits incurred, and of the prospects for a full recovery to the historic norm.
When an economy goes into recession substantial productive resources are rendered unproductive--factories, raw materials, and labor among them. As a consequence the tax base is considerably diminished at the same time as social welfare costs (unemployment compensation, food stamps, ADC, and Medicaid, as well as Social Security and Medicare payments to seniors retiring involuntarily) are dramatically increasing, creating substantial deficits even before stimulus spending. When a recession also sees real estate values drop sharply, the tax base for many state and local governments drops as well, often causing massive layoffs. Federal assistance to these governments increases the deficit as well.
When a recession occurs in the wake of substantial increases in private debt (credit cards, student loans, equity lines of credit, mortgages) the economic uncertainty causes even those with stable incomes to divert discretionary spending to the repayment of debt, lowering spending. The newly unemployed and those fearing unemployment also retrench, further lowering spending. The central bank during a recession acts to lower interest rates, but this also results in a diminution of income to net creditors and to retirees who accordingly reduce their spending. The deficit increases while private spending decreases. In America this household spending accounts for some 70% of American GDP and its reduction has a meaningful effect on the economy.
Since the spending of any one of us is the income of another of us, there is a rippling multiplier effect as reductions in spending are felt throughout the economy. The scarcity of discretionary spending causes companies to avoid investment in production, slowing new hiring and jeopardizing current employees. Because there is no demand despite an extremely low opportunity cost of funds, there can be no "crowding out" of private investment. Without demand there is little upward wage pressure, and little danger of inflation. As far as default goes, the U.S. debt is denominated in dollars, and as long as there is one tree standing, it is impossible for the U.S. to be forced to default on its debts. (Foreign exchange rates can be relatively affected though, but a cheaper dollar means more exports and less imports, which helps the U.S. economy.) The short term consequences of deficits during a recession are not alarming.
Nonetheless, excess public debt needs to be reduced in the long term. Overwhelmingly, economists believe that if normal levels of economic activity are restored, the reversal of all the multiplied reductions in productive resources returning the economy to an historical normal growth rate can easily reduce the debt adequately through historically normal levels of taxation. As you say, whether or not this is a correct assumption--despite the mountain of historical data supporting it--is not certain.
What is assured, though, is that if unemployment remains high--and it tops 8% in several highly-populated states, and 22% for those under 25--we will create a permanent class of unemployable or underemployed. Young people who have no chance to develop necessary skills in entry-level positions will be passed over for the newest crop of graduates, and older workers who haven't worked for a year or more will have great difficulty being hired even in a recovering economy. Every day that we fail to add the fiscal stimulus the economy desperately needs to the extraordinary monetary stimulus the Fed has been feverishly supplying raises the likelihood that we are so degrading our workforce and our infrastructure that full recovery will be impossible. And if buyers of our sovereign debt lose confidence that our government can act decisively to address our economic challenges, then we risk losing one of our greatest economic tools--having our currency serve as the reserve for the world.
So while there is some risk that if we increase our public debt it may remain high and costly for longer than we expect, the decade-long experience of Japan has proven to a certainty that trying to recover from a deep recession with half-measures, and pulling back stimulus at the first sign of recovery, serves only to prolong the misery. The 1937 experience of the FDR administration teaches the same lesson.
This is one case, I think, where the cure can not possibly be worse than the disease.
