On Budget Deficits

From: William F Hummel (wfhummel_at_comcast.net)
Date: 08/12/04 

Date: Thu, 12 Aug 2004 21:53:11 GMT

                            The "Evil" of Budget Deficits

"The national deficit is like a cancer. The sooner we act to restrict
it, the healthier our fiscal body will be, and the more promising our
future." ... Senator Paul Simon.

"Our nation's wealth is being drained drop by drop because our
government continues to mount record deficits. The security of our
country depends on the fiscal integrity of our government, and we're
throwing it away." ... Senator Warren Rudman.

Warnings of this type are commonplace today. The thought behind them
is that some day the government will be unable to service its growing
debt, in short that it will become bankrupt. This is based on the
mistaken belief that government borrowing is no different from private
borrowing. Individuals and firms can indeed borrow their way into
bankruptcy. The government cannot, as long as it borrows in the same
fiat currency that it creates.

The fiat money system that replaced the gold-based system in 1971
ended the dependence of government spending on tax revenues. No
longer is spending constrained by the amount of gold the Treasury
holds. Today the government has just as much money at its disposal
when there is a budget deficit as when there is budget surplus.
Indeed there is no practical limit to what the government can spend
under a fiat money system. The only constraint is self-imposed.

Yet government fiat money is still treated as a scarce economic
resource. Congress decides on the affordability of a program based on
how much money is projected to be available from taxes or spending
cuts. "Revenue neutral" is now the password for fiscal
responsibility. Some go further and insist the debt should be retired
altogether. That would be a serious mistake for a number of reasons,
including its effect on the role of the US dollar as the world's
reserve currency.

The choice between taxing and borrowing is entirely at the discretion
of Congress. That choice does have an economic impact and deserves
proper consideration. Unfortunately fiscal policy is based on the
belief that deficit spending is ipso facto evil. The real economic
consequences are seldom considered in that decision.

Once policy makers realize that government deficits presents no
financial risk, their decisions on spending can be made on the basis
of real economic benefits and weighed against real economic costs,
rather than on imaginary financial constraints. All too often their
attention has been directed toward meaningless issues of accounting.

There are times when the attempt to balance the budget can be
counterproductive. In fact deficits are usually unavoidable during
recessions. When the economy is sluggish or in recession, deficit
spending will usually provide the boost in aggregate demand needed for
recovery.

It is widely believed the government borrows in order to cover its
deficit spending. That is a misconception. The reason it borrows is
to soak up the unwanted reserves that would otherwise accumulate in
the banking system due to deficit spending. Absorbing unwanted
reserves is necessary to enable the Fed to maintain control of the Fed
funds rate. That rate is the bench mark for all short term interest
rates.

Selecting and controlling the Fed funds rate is the basic monetary
policy instrument of the Fed. It is how the Fed influences the
liquidity of the private sector in its effort to steer a path between
recession and unemployment on the one hand and inflation on the other.

The need to control the Fed funds rate means that the government
cannot spend without borrowing or taxing, and it cannot borrow or tax
without spending. Maintaining this balanced reciprocal flow of funds
between the government and the banking system is fundamental to
managing the cost of money to banks, and thus to the economy at large.

Fear that the government will some day be unable to borrow from the
public reflects a misunderstanding of the process. Deficit spending
creates new bank deposits and reserves in the amount of that spending.
Since reserves earn no interest, banks will normally hold no more than
required. However the banking system has no way to dispose of excess
reserves except to buy government securities. Thus banks will always
be willing to buy the interest-earning, risk-free securities offered
by the government, up to the amount of their excess reserves. And
since the government can pay whatever interest rate the market
demands, there will be no shortage of bids from the public for those
securities.

William F Hummel

Relevant Pages

  • Weak US Dollar
    ... "Unprecedented spending, unending fiscal deficits, unconscionable accumulations of government debt: These are the trends that are shaping America's financial future. ... Mr. Obama promises to lower the deficit from its current 9.9% of gross domestic product to an average 4.8% of GDP for the years 2010-2014, and an average 4% of GDP for the years 2015-2019. ...
    (comp.sys.mac.advocacy)
  • Re: Money supply and national debt -- need help on this subject
    ... My assertion is that one reason the government may want to avoid ... Spending is the tool that determines the scope of government and the ... Spending necessarily determines the amount of taxes collected, ... is because the borrowing of $1 must be serviced by the govt paying ...
    (sci.econ)
  • Re: OT: The Fear Merchants
    ... economy would recover faster once people did so. ... started in on the Republican talking points of President Obama spending more ... out of the "Great Depression" was the government spending on WWII (among ... deficit spending can't go on forever without dire consequences. ...
    (rec.bicycles.tech)
  • Re: OT: The Fear Merchants
    ... The "gloom and doom" caller started in on the Republican talking points of President Obama spending more money and having a bigger budget, and Ed told him that what brought the US out of the "Great Depression" was the government spending on WWII. ... it became clear to me that the RNC has sent out the word to all of their talk show minions to "spread fear" because this is the best way to keep the economy bad. ... Our current debt servicing is 16% of the federal budget, deficit spending can't go on forever without dire consequences. ...
    (rec.bicycles.tech)
  • Re: Money supply and national debt -- need help on this subject
    ... Spending is the tool that determines the scope of government and the ... Spending necessarily determines the amount of taxes collected, ... is because the borrowing of $1 must be serviced by the govt paying ...
    (sci.econ)
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