Deficits and Debt Do Matter

Nobel Prize winning economists can be wrong.  On January 28, 2013, while promoting his new book, economist Paul Krugman told viewers on MSNBC’s Morning Joe that deficits don’t matter.  He has probably said that before, but his remarks should be viewed with renewed interest and scorn because they run counter to what is playing out in the U.S. economy and the halls of Congress right now.  The government reported on Wednesday that the U.S. economy contracted by 0.1 percent in the fourth quarter, the first time growth has been negative since mid-2009. Analysts expected the GDP growth to be 1 percent to 1.2 percent.  This period of economic growth occurred during a time when Congress raised taxes on the job creators and even middle class Americans.  Budget battles over the last two years have been precisely about deficits and debt and the United States experienced a credit downgrade in the summer of 2011 as the country struggled through a debt ceiling increase.

As Morning Joe host Joe Scarborough wrote in a Politico op-ed in response to Krugman’s appearance on his show, “His argument also runs counter to what I have been saying in Congress and in the media since 1994.”  Scarborough went on to elaborate who else agrees with him, “Council on Foreign Relations president Richard Haass, who agrees with former Joint Chief chairman Michael Mullen, that longterm debt poses the greatest threat to America ‘s national security. Richard took exception to the suggestion that deficits don’t matter and that longterm debt can be pushed to the side for years to come. Mr. Haass, Admiral Mullen and former Clinton chief of staff Erskine Bowles all believe that entitlements and debt are the most pressing challenges we face as a country over the next few decades.”

One case in point that runs contrary to Paul Krugman’s views that deficits and debt don’t matter is Japan.  Japan faced a similar housing bubble in the 1990s that America faced in 2007-2008 which led to the current economic crisis.  Like America, Japan tried to spend its way out the economic crisis with little success and a whole lot more debt.  As AEI scholar John Makin wrote about the two countries, “Japan’s economy has stagnated while its debt burden has risen from about 15 percent of GDP in 1990 to nearly 140 percent today (or 220 percent, including debt held by Japan’s government agencies like the post office). Most of this sharp rise in Japan’s debt-to-GDP ratio (from 40 to 140 percent), has come since 1997, and like America’s ratio, the pace of increase rose sharply after 2007. “   Japan was not able to spend it way out of an economic crisis and America should learn from its mistakes.

Krugman argues that interest rates are at historic lows and that interest on the debt is minimal at $220 billion.  The problem is that interest rates will not always be this low and once we see an increase in interest rates, we will see a corresponding increase in the interest on the debt.  Plus, spending $220 billion a year is never insignificant.

So debts and deficits do matter because they have consequences.  And, as finance writer  Shah Gilani noted about debt, “Too much debt leads to depreciation and deleveraging, which leads to lower demand, lower production, fewer jobs and a lower tax base.”  America cannot afford any more bad economic news and politicians would be wise to heed the advice of someone other than Paul Krugman.