Cross-posted from Smirking Chimp
Are you worried about the government running deficits in the hundreds of billions of dollars and a debt in the trillions? If so, then you should be really angry at people calling for the Federal Reserve Board to raise interest rates. If the rate hikers get their way, they will add trillions of dollars to the debt burden borne by our children and grandchildren.
Okay, I'll stop with the deficit hawk garbage, but there is a simple point here. If the Fed slows the economy and keeps people from getting jobs, we will face larger budget deficits.
This is about as straightforward as it gets. When the unemployment rate falls, more people have jobs and are paying taxes to the government. Also when people are working, they are less likely to be getting benefits like unemployment insurance and food stamps. Therefore, as we get to lower levels of unemployment, the deficit gets smaller.
We saw this very clearly in the 1990s. The Big Lie that the Clintonites like to tell is that their hero flipped the budgets from large deficits to large surpluses and then George W. Bush pissed it all away with his tax cuts and wars. That's a great fairy tale, but it's very far from the truth.
The spending cuts and tax increases Clinton put in place did reduce the deficit, but they only got us about half way to a balanced budget. In 1996, after all the tax increases and spending cuts had been written into law, the Congressional Budget Office still projected a deficit for 2000 equal to 2.7 percent of GDP (at $470 billion in today's economy). Instead we ended up with a surplus of close 2.4 percent of GDP.
This shift from deficit to surplus of more than 5 percentage points of GDP (@ $860 billion in today's economy) came from lower unemployment. It did not come from deficit reduction measures.
In 1996 the Congressional Budget Office projected that the unemployment rate in 2000 would be 6.0 percent. This was in keeping with the conventional wisdom at the time, which held that inflation would spiral upward if the unemployment fell below 6.0 percent.
Fortunately Alan Greenspan, who was the Federal Reserve Chair at the time, did not accept the conventional wisdom. He saw no reason to prevent the unemployment rate from falling. He ignored the inflation hawks of that era and said that he would allow the economy to keep growing. As a result, millions more workers got jobs and tens of millions of workers got pay raises.
Yes, and we also got a budget surplus. That surplus disappeared when the stock bubble that was driving the late 1990s growth collapsed. But it was this growth and the resulting drop in unemployment that eliminated the budget deficit, not the deficit reduction policies of the Clintonites.
There is no particularly good reason to be worried about budget deficits. (Japan's debt is three times the size of ours relative to its economy, yet it can still borrow long-term at less than 1.0 percent interest.) But deficit phobia is a guiding principle of our economic policy, so why not take the budget hawks at their word. If they really think that the deficits we are running to today are imposing burdens on our children, then they should be the first ones in line demanding that the Fed keep its foot off the brake and allow the economy to continue to grow.
As a practical matter, the leaders of the anti-deficit crusade are unlikely to show this sort of consistency. Their efforts seem more focused on cutting Social Security, Medicare and various safety net programs than any real concerns over the deficit. They have rarely displayed much honesty in pushing their agenda, even resorting to crass racism to try to heighten fears. (The linked ad highlights debt to China. We owe money to China because of the trade deficit, not the budget deficit.)
While leaders of the deficit reduction drive may not actually care about budget deficits, tens of millions of politically active people do. These people should know that if they want to see lower deficits they should be trying to keep the Fed from raising interest rates.
The concern over budget deficits may be misguided, but if we can't educate these people about the relationship between deficits and the economy, perhaps we can at least turn their concerns to a positive end. The prospect of higher unemployment and lower wages are the real reasons for opposing Fed rate hikes. But hey, if people really care about budget deficits, then they should join the anti-rate hike coalition.