Should we be worried about the rising federal deficit? If not, when should we start worrying – when it hits $1 trillion a year? $2 trillion? Never? That’s the topic of debate in a Bloomberg piece Monday, between economists Stephanie Kelton and Noah Smith.
Kelton, a professor at Stony Brook University who served on the staff of the U.S. Senate Budget Committee and advised Sen. Bernie Sanders during the 2016 campaign, is an increasingly well-known spokesperson for a school of thought called modern monetary theory, which emphasizes the U.S. government’s ability to create its own money, insulating it from worries about default. Kelton says that deficits aren’t a problem right now and won’t be until rising inflation signals that the economy is running out of unused resources. Smith, a former professor at Stony Brook University who now writes for Bloomberg, represents the more mainstream view that large deficits are inherently problematic, for both their depressive effects in the economy and the risk of inflation they create.
Here are a few highlights from their debate:
Kelton on why she’s not worried about the deficit right now: “Is there a limit to how big the deficit can safely climb? Absolutely! Deficits matter. They can be too big — risking accelerating inflation. But they can also be too small, robbing the economy of a critical source of income, sales and profits. At some point, something will happen to undermine the strength of demand in the U.S. economy, and the expansion will end. Given the current inflation outlook, I see no reason to believe that trillion-dollar deficits pose a risk to the expansion.”
Smith on the current risk of running large deficits: “If deficit-induced inflation comes slowly, we don’t have much to worry about, because we can see it coming and adjust policy accordingly. But if it comes quickly — if the economy switches suddenly between a low-inflation equilibrium and a high-inflation equilibrium — then the dangers of deficits wouldn’t become apparent until it was too late. Of course, we can never know where that breaking point is, so it’s hard to decide just how much precaution to take. But with the labor market looking very strong, it seems like the potential benefit of large deficits at this point in time is small. So it seems like an unknown risk in exchange for only a small potential gain — not the most enticing of gambles.”
Ben Ritz, a deficit hawk of sorts at the Progressive Policy Institute, provided a centrist’s view on the debate, tweeting, “I'm sympathetic to @StephanieKelton's argument that lack of inflation today means deficits aren't currently hurting the economy. At least in the short term, she's probably right.”
In the long run, however, the fiscal debate must address the large and growing structural deficit driven by the rising costs of retirement and health care, Ritz says. If inflation does pick up, signaling the need for a pullback in federal spending, how will the government respond? “To cut those deficits, we either need to raise middle-class taxes or cut big entitlements like #SocialSecurity & #Medicare,” Ritz writes. To avoid that unpalatable dilemma, Ritz suggests a middle road, albeit one that may not satisfy either side of the debate: “So if we're gonna give #MMT's worldview a shot, it should be with discretionary spending in long-lasting public investments that can easily & quickly be dialed back when inflation strikes. Pumping up entitlement-driven structural deficits is a recipe for misery.”