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  • Cited by 4
  • Print publication year: 2008
  • Online publication date: December 2009

5 - Economic Perspectives on Federal Deficits and Debt



Are large deficits good, bad, or irrelevant? In fact, they can be each, depending upon circumstances. Large deficits potentially cause two separate but related problems: shifting the bill for financing the current generation's consumption to future generations and crowding out private investment. Thus, deficits are more problematic well into a solid economic expansion; when their impact is primarily on domestic investment and hence future income, rather than private saving or foreign capital imports; when the level of the national debt, the accumulation of all previous deficits, is high or rapidly rising toward high levels; when they finance consumption, not productive public investment; when they do not constrain future spending; or if they lead to inflationary monetary policy. So the net effect of the budget position in any given year likely reflects a balancing of these considerations. Despite all the rhetoric, serious deficit-induced economic problems are unlikely over the next decade, although longer-term budget problems are potentially far more serious.

Further, the usual nominal dollar measures of the deficit and debt can be extremely misleading. The deficit and debt must be compared to the size of the economy, a rough measure of its ability to service the debt. Thus, debt burdens often are proxied by the debt–GDP ratio. The deficit is affected heavily by the business cycle. Inflation erodes the value of the previously issued national debt; in other words, the real debt declines with inflation (and conversely increases with deflation).