Re: Deficit - so what?

["Per Gunnar Berglund" <pgberglund@xxxxxxxxxxx>]

In response to Sven Larson:

It is comforting to see that American pragmatism puts common sense and
sanity before any obscure financial dogmas about balancing the budget.

What worries me, however, is the long-term perspective - the goal of 'paying
down the public debt'. The recent sharp reduction of the U.S. debt-to-GDP
ratio may well have caused some portfolio imbalance undermining private
demand in the longer perspective. The recently discussed stimulus package is
most probably too small and will suffice only to remove the 'fiscal drag' of
the Clinton expansion.

Robert Eisner, in his 1997 pamphlet on 'The Great Deficit Scares', argued
that the very concept of 'balance' in budgets or trade needs be modified
when dealing with growing systems like an economy. He suggested that the
budget should be deemed in balance whenever the debt-to-GDP remains stable
over time. I believe a lot would be gained by adopting this more
economically meaningful conception of the deficit. Under today's standard, a
'balanced' budget means that any economic growth will reduce the debt-to-GDP
ratio, which will inevitably cause portfolio imbalances because the
proportions between public and private wealth will shift. 'Balancing' the
budget should not involve imbalancing in the economy. Tom Palley, too, makes
the same argument in a new article in Challenge, which I recommend everybody
on this list to read.

Clearly, if the economy grows long-term at (say) 6% per year in nominal
terms, then so can the public debt, without causing any real 'imbalances' in
the economy. For if it does, the debt-to-income ratio will remain unchanged,
and income is the resource flow out of which we service debt. So if the debt
grows in line with our capacity to serve debt, there should be no problem.
But if the debt is (say) 50% of GDP to begin with, and it can grow at 6% per
year, then we must run a permanent 'deficit' (on our present accounting
standards) of 3% of GDP just to keep that debt-to-income ratio constant. Any
'deficit' of less than 3% of GDP will reduce the debt-to-GDP ratio and thus
cause portfolio imbalances that tend to depress the economy.

The conclusion, thus, is balancing the budget in the meaningful sense of
stabilising the debt-to-GDP ratio means running nominal 'deficits' of about
3% of GDP - every year, indefinitely. In this perspective the recent nominal
'surplus' of about 2% of GDP actually amounts to a huge actual surplus of
some 5% of GDP. Small wonder the economy is not doing all that well!

Deficits - so what? Well, deficits do matter. They can be too big or too
small. It depends on the present state of the economy, the potential growth
path of the economy, and on the debt-to-GDP ratio. I believe it is fair to
say that by any reasonable standards, the present fiscal stance is much too
tight, and what I fear is that the proposed stimulus will be way too small
to bring about long-term balance in the economy.

Best,
Per

_____________________________________________
Per Gunnar Berglund
CEPA    80 Fifth Avenue, 5th floor    New York, NY 10011
Tel: (212)229-5923    Fax: (212)229-5903



----- Original Message -----
From: "Sven R Larson" <larson@xxxxxx>
To: <pkt@xxxxxxxxxxxxxxxx>
Sent: Thursday, November 29, 2001 9:02 AM
Subject: Deficit - so what?


> After last year's disagreement between democrats and republicans in the
> presidential campaign over the budget deficit issue, it lloks like some
> sort of consensus is emerging from the awareness that there actually is
> a deficit ahead:
>
> http://www.nytimes.com/2001/11/29/business/29ECON.html
>
> An interesting passage:
>
> "Both sides said they were willing to run deficits for a year or two in
> an effort to revive the economy and pay the bill for national security."
>
> Of course, paying down the national debt is still a "priority". Despite
> that, the fiscal policy outlook is slightly more positive in the US than
> in the EU.
>
> Agree?
> /srl
>
> --
> Sven R Larson
> Ph.D.; Assistant professor of economics
> Department of Social Sciences, 22.2
> Roskilde University
> PB 260
> DK-4000 Roskilde, Denmark
> http://www.ruc.dk/english/
>