Why government spending should continue (or increase!)

Yesterday I argued that our current national impulse to cut government spending is hurting the economy. The numbers clearly say that falling government spending on all levels has hurt our economic growth and our job growth over the past 6 months to a year. This elicited a response from a commenter who strongly disagreed with my point. I think it would be good to discuss and completely respond to his reasoning. This is not to pick on the commenter, but because I think that his/her view is held by many (not just on the right, either!) and it needs to be responded to. He/she said:

Spending = borrowing = debt = interest payments = more debt = no growth, just interest payments building up and up and up.

When the market wises up to the scam that is the US economy, bond prices will tank, interest rates will soar, and then the US will find out what a scam (so called) Keynesian economics is!

The commenter points out that typically, the more the government spends (ignoring tax rates), the more debt it builds up, and when it has a lot of debt, the government’s interest payments go up. He also alludes to the fact that when the government’s interest rates rise, so do interest rates in the private sector (like for bank accounts, mortgages, car loans). Since high interest rates are generally bad for a damaged economy like ours, he (like many) thinks we should stop deficit spending.

The major problem with this economic view

…is that the US government has engaged in record amounts of deficit spending recently and interest rates have actually remained at record lows. Right now, the government can borrow money almost for free! Government bond prices are set by the free market, and right now if you invest $100 dollars in a 3 month government bond you will get back $0.01 at maturity. Investors are rushing to be paid one cent on a hundred dollar loan! Far from being a “scam,” investing in US government debt is investing in the US economy, which is the safest investment in the world. People want to buy US government debt so badly that they will LOSE  MONEY (once you account for inflation) in order to buy our debt.

But maybe this is only temporary and investors will “wake up to the scam that is the US economy,” as the commenter suggests. If that happens, investors could demand higher interest rates and our borrowing costs could increase substantially. However, that’s not likely to happen for a long time. As Dylan Matthews explains, “currently, the average maturity of U.S. debt is 62 months, almost a year less than its peak of 72 months in 2001.” Investors are betting that interest rates will not rise above their current low, low levels until late 2016. US debt is almost as secure now as it was in 2001 when we were enjoying the Clinton surplus!

The other side of the equation

The commenter and most of the anti-spenders like to point out that “spending=debt=interest payments*(sometimes)*=more debt” but what they conveniently forget is the  other side of the equation. The other side is that government spending=increased demand=more jobs=economic growth=more  jobs, etc. As much as the anti-spenders hate to admit it, deficit spending has both positive and negative effects. The positive effects are that when the government spends money it employs people and buys goods, which stimulates the economy. The negative effects come into play when interest rates rise. The task for policy-makers is to find out which side of the equation is greater if they want to deficit spend.

So how does all that apply to our current situation? Well as I’ve established, there are almost zero drawbacks to deficit spending right now, while the potential beneficial effects of deficit spending are huge! The equation is hugely balanced in favor of deficit spending. The market and the economy are desperate, desperate for more government spending. Here’s Paul Krugman on this subject:

Those plunging interest rates and stock prices say that the markets aren’t worried about either U.S. solvency or inflation. They’re worried about U.S. lack of growth.

Ezra Klein sounds the same note as well:

As the markets shake and churn, investors are rushing to buy Treasury debt. They’re lending to us money for three-months for nearly nothing, and for 10 years at 2.4 percent. That’s the lowest rate since the 1950s. (emphasis mine) The problem for the market is that the American government is not giving them enough debt to buy.

But the problem for American stocks, for American companies, and for the American economy is we’re not giving the market any reason to believe we’ll recover anytime soon. Where is the demand going to come from? Who is going to buy their products?

There you have it, government spending is just not a problem the market is worried about. Companies don’t care about US debt, they care about people buying their products! Who is going to start buying their products? The government is the only entity who has the ability to rescue the economy from this economic slowdown. The questions that policy makers and indeed all Americans need to consider are: Do you want to be stuck in a downturn for years and years to come? Or do you want the government to stop cutting spending and invest in American firms and workers? Do you want the government to twiddle its thumbs while it has the weapons to slay this economic dragon? Or do you want the government to use the considerable tools in its arsenal to jump-start the economy?

(Update 08/06: I wanted to make it clear that obviously deficit spending cannot go on forever. In an ideal world, the government would increase spending to solve our short-term economic woes while also setting in place a comprehensive plan to bring our long-term deficits under control. That’s the best of both worlds)

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