Bruce Bartlett (2003) on How Fiscal Policy in the Absence of Monetary Offset Can Be Nearly Self-Financing Through Demand Channels Alone
DeLong-Summers "Simplistic Keynesians" Smackdown Watch: Kenneth Rogoff

Laura D'Andrea Tyson: Fiscal Policy in a Depressed Econoy


Confusion About the Deficit: Is a decrease in the federal budget deficit good or bad for jobs and growth in the American economy?… Based on misleading political rhetoric — a naïve assumption that government budgets are like individual or family budgets (and poorly taught economics courses) — most voters believe that a large government deficit is necessarily bad for the economy. Following this logic, the large spending cuts and tax increases scheduled to occur in January 2013 should be good…. But the Congressional Budget Office has just issued a sober warning that these measures, which would reduce the fiscal deficit by about 5 percent of gross domestic product between 2012 and 2013, are likely to throw the economy back into recession.

Even Mitt Romney, who is attacking President Obama for fiscal profligacy and has pledged to balance the budget if he is elected, has acknowledged that slashing more than a trillion dollars from the deficit next year would bring on another recession….

[D]oes that mean an increase in the deficit would be good for the economy?… The effects of an increase or a decrease in the deficit depend on the economy’s specific conditions. Under current conditions, an increase in the budget deficit would be better for the economy than the decrease scheduled to take effect next year….

By itself an increase in the deficit, either in the form of an increase in government spending or a reduction in taxes, causes an increase in demand. But how this affects output, employment and growth depends on what happens to interest rates. When the economy is operating near capacity, government borrowing to finance an increase in the deficit causes interest rates to rise. Higher interest rates reduce or “crowd out” private investment, and this reduces growth…. When there is considerable excess capacity, an increase in government borrowing to finance an increase in the deficit does not lead to higher interest rates and does not crowd out private investment. Instead, the higher demand resulting from the increase in the deficit bolsters employment and output directly, and the resulting increase in income and economic activity in turn encourages or “crowds in” additional private spending. The crowding-in argument is the right one for current economic conditions….

The remarkable combination of surging deficits and falling borrowing rates for the federal government indicates that the American economy is slowly recovering from a balance-sheet recession…. As part of deleveraging, the private sector has also increased its demand for safe financial assets and has been willing to pay a premium for them. In terms of liquidity, risk and returns, Treasury bills and bonds are the closest thing to cash. They can be used as collateral to secure lending and as a convenient place to store savings without much costly due diligence…. Indeed, the demand for such debt is so strong that the Treasury is exploring how to let investors enter negative yields when bidding at its auctions. Despite fear-mongering by deficit hawks, there is no evidence of bond-market vigilantes poised to flee United States government debt because of concerns about the government’s creditworthiness…. Under prevailing economic conditions, there is a strong case for expansionary fiscal policy, even at the expense of an increase in the deficit. Additional fiscal support would increase output and employment now…. The question that needs to be asked is whether the future gains in potential output and growth that would result from expansionary fiscal policy today would outweigh any future losses of output and growth caused by the repayment of the government’s additional debt. Under current conditions, with a significant gap between actual and potential output, a high rate of long-term unemployment and a real government borrowing rate at zero or lower, the answer to this question is almost certainly yes.

Indeed, Lawrence H. Summers and J. Bradford DeLong assert in a recent paper that under these conditions, expansionary fiscal policy is likely to be self-financing – the future gains in potential output are likely to offset the policy’s cost. The self-financing hypothesis is particularly compelling for expansionary fiscal policies targeted at investment. The government can currently borrow funds and repay less than it borrows in constant dollars. Many job-creating public investment projects in education, research and infrastructure would earn much higher rates of return in terms of future growth. The government could also borrow to finance new loan-guarantee programs and tax incentives to leverage private investment in these areas….

[I]nsufficient private spending rather than excessive government borrowing is what is impeding job creation, discouraging investment and eroding skills. Under these conditions, additional growth-enhancing fiscal measures to “crowd in” private spending are warranted.