While short-term fiscal deficits may play a remedial AD role there are significant differences of opinion about their use.

  • One of those is that fiscal policy is very hard to employ in a timely way and there is much controversy about the strength of its impacts.
  • Second, deficits tend to be habit forming and many economists agree that long-term persistent deficits are not good for a nation.

Nevertheless, we see persistent deficits in many countries. Even today in the U.S., we make little progress against deficits. Why is that? Why does it seem so hard for governments to keep away from deficit spending? There is no simple answer but surely at the root is the idea that many of us benefit from government programs. Once we receive government benefits we relish and count on them.

For example, homeowners in the U.S. may take their mortgage interest paid as a deduction from their income taxes. This “entitlement” is not anything that many of us would relinquish readily. Most of us would not like higher taxes either.

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For the government to make headway against a large deficit, it would have to legislate changes that impact many of us. While most of us say that we prefer smaller deficits, very few of us want our entitlements reduced or our taxes increased. Combine this with the idea that the worst impacts of government deficits are not readily apparent – they do not result immediately and obviously. Combine this with the idea that economists and politicians do not fully agree on when and how the negative aspects of deficits will manifest themselves. The result of all this is that we have a lot of politicians and voters who will not vote for the necessary changes. It is very much like buying a very expensive and painful new medicine. Until the very worst signs of the disease are upon you and until all the doctors show much more agreement about the disease and the medicine, you might postpone the purchase.

A good example of this point comes from an article by Alan Reynolds, a senior fellow at the Cato Institute and an economist long associated with supply-side economics (more on that topic in the Note on Aggregate Supply). The title of his interesting and provocative article is “Deficits, Interest Rates, and Taxes: Myths and Realities,” (Policy Analysis, June 29, 2004 or at http://www.cato.org/pubs/pas/pa517.pdf). He ends the article with this statement, “In reality, neither actual nor projected budget deficits raise real or nominal interest rates, steepen the yield curve, reduce national savings, cause “twin deficits”, or make the dollar go up or down. The logic behind such speculations is flawed and contradictory and the evidence is nonexistent.” He goes on to argue that the problem is not so much the deficits but the excessive government spending and the high tax rates that accompany the deficit. This article suggests why voters might not be so sure about paying a high price for deficit reduction today if there is such strong difference of opinion about their negative effects.

Martin Feldstein puts the current size of the federal budget deficit into perspective. He is less extreme than Reynolds, but he does try to show that deficits were not as alarming as others were saying in 2004. He joined Reynolds in arguing that a large tax increase is not a prudent policy. “Here are the Facts, Wall Street Journal, February 12, 2004. By Martin Feldstein. This article is available at: http://www.nber.org/feldstein/wsj021204.pdf