The Economic Effects of Deficits and Surpluses
August 9, 1999
Lately, both Republicans and Democrats seem convinced that huge budget surpluses have enormous and positive economic effects. Hence, many oppose tax cuts because they believe that paying down the debt will be better for the economy. There is very little evidence that the debt imposes a significant economic burden and, consequently, there is no reason to think that paying down the debt offers much economic benefit.
The paying-down-the-debt-is-good notion originated from the idea that deficits -- the annual increment to the debt -- have extremely negative consequences. But during much of this century deficits have been viewed as good, according to the economic theories of John Maynard Keynes, who held that deficits stimulate the economy. Thus during recessions, almost all economists have said the government should run big deficits to get the economy moving.
A review of the academic literature finds little evidence that deficits cause inflation or raise interest rates. Inflation, economists now generally accept, is caused exclusively by the Federal Reserve's monetary policy. Thus we have had rising prices when the deficit was low and falling prices when it was large.
The impact of deficits on interest rates is more ambiguous. Some studies show a small impact, others show none. Consequently, the presumed beneficial effect of surpluses must be equally small.
There is no question that the Democrats' recent conversion to the religion of fiscal responsibility is insincere. The instant that the economy begins to slow they will go back to the Keynesian church of deficits-are-good. Republicans should understand that while paying down the debt is not bad, it is not necessarily any guarantee of low inflation and interest rates. The truth is that the Federal Reserve has far more to say about both than anything Congress does.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, August 9, 1999.
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