How Washington Learned to Love Debt and Deficits

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The theories about debt and deficits and whether they matter—once widely shared in Washington, on Wall Street and in academia—have fundamentally changed. Political support for taming deficits has melted away, with Republicans accepting bigger deficits in exchange for tax cuts and Democrats making big spending promises around 2020 election campaigns. Global demand for U.S. Treasury assets has displaced the “bond-market vigilante” mentality of the 1990s that scared Washington.

Leading scholars, in a mini-revolution hitting academia, are debating whether large federal debt and deficits might be tolerable. They aren’t a top concern for voters anymore, either. Even some former deficit hawks say rising government red ink might not be the grave problem they once believed. The new bottom line: The U.S., despite a record-long economic expansion, is on course to test just how much it can borrow.

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In theory, an increased supply of government bonds—sold to raise funds when spending exceeds revenues—should increase government borrowing costs. Theory also says big deficits crowd out business borrowing and increase private borrowing costs, too. The opposite has happened. While government debt soared after the 2007-09 financial crisis, 10-year Treasury yields have fallen to near 2% from more than 5% in 2006, holding down government interest payments. U.S. business debt rose to $15 trillion in 2018 from $9 trillion in 2006.

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A recession would test how much debt the government is prepared to accumulate. Spending on safety-net programs like unemployment insurance rises during recessions, and tax receipts fall. Policy makers are pressured to increase spending or cut taxes to stimulate growth—so when the economy sinks, already large deficits will soar. Countries with high debt before crises have weaker recoveries, partly because policy makers pull back on stimulus quickly for fear of pushing debt levels too high, found University of California, Berkeley economists Christina Romer and David Romer.

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The federal government has run deficits in all but four of the past 50 years. Budget deals during the George H.W. Bush and Clinton administrations, which included tax increases on high-earning Americans, and spending cuts, plus economic growth, put the budget in the black in 1998 for the first time since 1969... But recession hit in 2001. Republicans cut taxes, and America spent on wars in Afghanistan and Iraq. A financial crisis, and another recession starting in 2007, led to bank bailouts, safety-net-program spending and hundreds of billions in fiscal stimulus. Publicly held debt swelled to 76% of gross domestic product in 2016 from 32% in 2001.

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https://www.wsj.com/articles/how-washington-learned-to-love-the-deficit-11560436380 (paid subscription)