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The Deficit Is Big, but Is It Bad? (ALEX BERENSON, July 20, 2003, NY Times)

At first glance, it appears that deficits, a sign that the government is living beyond its means and borrowing money that would otherwise be available for more productive private investments, must be a bad thing.

"There's something deeply emotional about federal budget deficits," said Jim Grant, the editor of Grant's Interest Rate Observer. "People seem forever inclined to latch onto government profligacy as the cause of higher rates."

Yet most economists do not think deficits are bad in principle, especially when the economy is weak, as it has been since 2001.

When growth is slow, increases in government spending can play an important role in taking the place of private demand, they say. Larger expenditures for unemployment and Social Security increase the deficit, but provide a cushion to people who have lost work. Tax cuts and rebates can also be useful, giving people more money to spend.

Besides, as a percentage of America's economy, the current deficit is still smaller than those run up in the 1980's.

So there is no reason to be alarmed, said Donald H. Straszheim, president of Straszheim Global Advisors and the former chief economist at Merrill Lynch.

"Count me on the side that says don't worry," Mr. Straszheim said. "This is largely the result of weakness in the economy."

Some analysts go further, arguing that deficits have very little impact even in the long run. If big deficits are really a sign that the government is borrowing money that private businesses need, than interest rates should rise when deficits rise, because the government would be competing with business for the same pool of money. But Japan has run enormous deficits for the last decade, swelling its national debt to more than $5 trillion, the world's largest, while Japanese interest rates have fallen close to zero.

Similarly, in the last two years, interest rates on United States Treasury bonds have fallen to their lowest levels since the 1950's, despite the free-fall from surplus to deficit.

"You can't convincingly correlate the rate of growth in the federal debt with the level of rates," Mr. Grant said.

Based on those experiences, Mr. Grant and others argue that interest rates are much more closely related to inflation and the broader health of the economy than to the year-to-year change in government deficits.

The theory may be wrong, but it is indisputable that rates went up as we went into surplus and came down as we went back into debt. We're with Macaulay:

At every stage of the growth of the debt the nation has set up the same cry of anguish and despair....[After the Napoleonic Wars] the funded debt of
England...was in truth a fabulous debt; and we can hardly wonder that the cry of despair should have been louder than ever. Yet like Addison's valetudinarian, who continued to whimper that he was dying of consumption till he became so fat that he was shamed into silence, [England] went on complaining that she was sunk in poverty till her wealth showed itself by tokens which made her complaints ridiculous....The beggared, the bankrupt society not only proved able to meet all its obligations, but while meeting these obligations, grew richer and richer so fast that the growth could almost be discerned by the eye.

Posted by Orrin Judd at July 20, 2003 3:46 PM