So writes Dylan Matthews (washingtonpost.com/blogs/wonkblog/) in edited excerpts from his original article* entitled Everything you need to know about the deficit.
[The following article is presented by Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and the FREE Market Intelligence Report newsletter (sample here – register here) and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Matthews goes on to say in further edited excerpts:
There are plenty of deficits that federal economic policymakers have to keep track of. There’s
- the current account deficit,
- the closely related trade deficit and
- the budget deficit that we’re going to discuss here which is the gap between the amount of money that the federal government is taking in… and the amount it’s spending.
Do we usually have a deficit?
For most of American history, we’ve been spending more than we take in, meaning we run deficits. For brief moments in the late 1960s and late 1990s we took in more than we spent, meaning we had surpluses, but surpluses are rare.
How big is the deficit?
The 2013 deficit is 3.9% of GDP, or 2.5% if you exclude interest payments. That works out to roughly $642 billion.
Is it going up or down?
The deficit’s definitely going down, as this chart from the latest CBO budget projections demonstrates, but will start growing again in a few years:
As a consequence, the debt load is expected to keep increasing:
Are the deficit and the debt the same thing?
- The deficit is the difference between revenues and spending in any given year.
- The debt is the total amount the U.S. has borrowed and still has to pay back.
How much debt do we have?
Debt held by the public (that is, not held by the government itself in trust funds and the like) is about $12 trillion, or 73% of GDP. That’s lower than the UK, France, Germany, Canada, Italy, or (especially) Japan, but larger than many Nordic countries, Australia, and South Korea.
Is borrowing all that money bad?
Depends how much interest you’re paying.
If we always paid below-inflation interest rates, then we’d be crazy not to borrow but sometimes interest rates can creep much higher. In 1984, real interest rates stopped just short of reaching 10%. That not only makes that year’s borrowing more expensive, it makes past borrowing more expensive, since debt is frequently rolled over; that is, past creditors are paid back with money borrowed from new creditors. If the rate at rollover is higher than the rate when the money was originally borrowed, then that old debt starts to cost more.
Does having a lot of debt hurt growth?
We don’t really know.
What evidence has been marshaled for this proposition, however, is remarkably weak. The best-known evidence was provided by a working paper from Harvard’s Carmen Reinhart and Kenneth Rogoff, which argued that high debt loads (in particular loads above 90%) are correlated with slower growth. The biggest problem with this is that it’s unclear from their data whether the high debt is causing the slow growth, or if it’s the other way around.
The mechanism by which high debt would hurt growth is unclear but it’s easy to see how slow growth could reduce tax revenue and increase unemployment and welfare payments, and so add on to the debt.[More recent] analyses have confirmed that the causal arrow went from slow growth to high debt, not the other way around.
- Arindrajit Dube, an economist at UMass Amherst, found that high debt loads are better correlated with slow growth before the debt gets that large as opposed to after, indicating that it’s the slow growth causing the debt and not the other way around:
The left chart [above] correlates debt-to-GDP ratios of a given year to the GDP growth rates of the next three years. If debt is causing slow growth, there should be a strong relationship but, except at the very low end, there isn’t. Meanwhile, the right chart correlates debt-to-GDP ratios of a given year to GDP growth rates of the previous three years. There’s a very strong relationship, indicating that slow growth causes high debt and not the other way around.
- Miles Kimball and Yichuan Wang at the University of Michigan did a similar analysis, and like Dube, found that high debt was better correlated with slow growth beforehand than with slow growth afterwards [see the 2 charts below], suggesting that Reinhart and Rogoff got their causality wrong assuming that Reinhart and Rogoff’s data was right.
UMass Amherst economists Thomas Herndon, Michael Ash and Robert Pollin, however, found that Reinhart and Rogoff made a key Excel error that had the effect of overstating the correlation between slow growth and high debt.
- Another paper, by David Greenlaw, James D. Hamilton, Peter Hooper and Frederic S. Mishkin, appeared to confirm Reinhart-Rogoff’s results, finding, “a country can quickly move from the group without problems to the group that faces nearly insurmountable problems if its debt rises significantly above 80% of GDP, particularly if it is running a large current-account deficit” but, as both Neil Irwin and the Atlantic’s Matt O’Brien have noted, this is driven by their inclusion of Eurozone countries that don’t control their own currencies. If you look at countries like the U.S. who control their money supply and, as a result, never have to default on their bills, the association goes away entirely.
That’s all a long way of saying that the case for high debt causing slow growth, rather than the other way around, is remarkably weak. If interest rates are very high, then a debt burden can become a serious fiscal problem but the evidence on growth doesn’t make for a strong case against adding debt.
How did we get all this debt anyway?
The best chart on this is the so-called “parfait chart” by the Center on Budget and Policy Priorities (CBPP), which breaks down what specific policies caused the big increase in the U.S. federal debt in the 2000s. Strikingly, the current debt was almost entirely caused by events in the past 13 years.[As the “parfait chart” below illustrates,] the most important factor was the Bush tax cuts of 2001 and 2003, which greatly reduced federal revenues and put the federal government into deficit after the surpluses of the late ’90s and early ’00s, but the economic downturn, the stimulus and other recovery measures, and the wars in Iraq and Afghanistan all played important roles too. Without those four things, we’d have a debt burden around 20% of GDP — far too small to even start to worry about, and smaller than every developed country other than Luxembourg:
What’s driving that increase?
It’s not that revenues are falling; in fact, they’re growing over the medium-term. The cause is an increase in spending – one that’s concentrated, overwhelmingly, on health care, with some Social Security thrown in.[As outlined in the table below,] Federal spending on major health-care programs was 4.6% of GDP in 2013, up from an average of 2.7% from 1973 to 2012. By 2038, it’s projected to increase to 8.0%. Spending on Social Security, currently 4.9% of GDP, will grow to 6.2% by 2038.
All other spending will fall from 10.0% to 7.1% but because the debt load is growing, the cost of servicing it will grow from 1.3% to 4.9%.
I’ve heard people say we need to “stabilize the debt.” What would that take?
A bit, but not a whole lot.
CBPP estimates [in Figure 1 below] that, now that the Budget Control Act (aka the debt ceiling deal, including sequestration) and the American Taxpayer Relief Act (aka the fiscal cliff deal, including the partial expiration of the Bush tax cuts) are in effect, it’d only take another $1.5 trillion in deficit reduction over ten years to stabilize the debt load.
[The above being said, however,] we might also want to replace some of the previous deficit reduction measures. The Budget Control Act cuts almost entirely from discretionary spending, [as can be seen in the graph below] which is decidedly not what’s causing the increase in spending going forward. Even if you want to cut discretionary spending, sequestration is a fairly blunt and dumb way of doing so.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
*http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/19/everything-you-need-to-know-about-the-deficit/?wprss=rss_economy (© 1996-2013 The Washington Post)
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