Rethinking macroeconomic approaches to debt

Macroeconomics

The government's policies that increased the debt in the 2008 were in general the right policies to make. There can be some debate about the nature of those policies -- whether it is wise to contradict market signals by bailing out the banking industry, for example -- but evidence-based policy is clear that deficits should be undertaken during times of economic distress in order to minimize that distress. The problem is not the debt taken out since 2008 during the recession, the problem is the debt taken out prior to that. Deficits should not occur during economic boom times. During those times, surpluses are required in order to help government prepare for the proverbial rainy day. "When the private sector is humming along…that's when government needs to tighten its belt."

Deficit spending during a recession is not so much good for growth and it helps to mitigate the downside risk of recession. Bernstein argues that government spending should be conducted in order to offset weakness in private sector spending. Thus, deficit spending is not necessarily expansionary, but it should be used to avoid economic contraction. Increased government demand offsets a reduction of private sector and family spending demand. In the past recession, we saw both as overleveraged homeowners were forced to stop consuming. Private business saw this reduction in demand and responded by restraining investment. If government does not spend at that point, then aggregate demand falls, plunging the economy into a negative feedback loop. Government spending simply avoids such feedback loops. Again, the issue here is that deficit spending during economic boom times is exactly the wrong policy, especially when it is spent on things that are unproductive (like billionaires' tax cuts, pointless wars and more benefits for the richest generation in history). "Borrowing to invest in productive infrastructure" is better than "borrowing to finance a weekend in Vegas" -- or a decade in some other place in the desert for that matter.

Bernstein also makes the point that government debt is not the same as household or business debt, and that is a valid point to make. There are a few differences of note. The first is borrowing -- government has much better ability to borrow than either business or households, the United States in particular. The size and diversity of the economy is one factor, the difficulty of putting a government into default is another, but also the U.S. has control over the value of its currency. It can devalue its way out of debt if need be, like Iceland did. Households and businesses do not have this luxury -- they are usually on very short leashes with their creditors, with grace periods measured in weeks and months, rather than decades.