Why the Deficit Should Be Bigger

Today the government can borrow money, amortized over 10 years, at just 2.6%.

What would you do if you could borrow a lot money at 2.6% amortized over 10 years?  Would you use it to finance a college education?  Would you buy a home or larger home?  Buy a house and rent it out for, 2-3 times your monthly interest payment?  Start a business?  Most of us, I think, could find some investment that would pay more than the 2.6% borrowing cost.

But here's the thing:  Because the government represents all of us, its expenditures on education, infrastructure and research ultimately benefit all of us, it can (and has) obtained returns far greater than we can earn as individuals.  And that doesn't even count Keynesian multiplier effects, which amplify the benefits tremendously.

This should be a no-brainer even if, despite all the evidence, you're an anti-Keynesian.  If you're an anti-Keynesian and think that hyperinflation is just around the corner, then this is a truly stupendous deal, since in real terms that nominal 2.6% rate is actually some big negative number.  It's almost free money.  What's the problem?

If you have actually followed the arguments, know the history, and have seen at the data (1937, the Great Depression, Japan and all that) and realize expansionary fiscal policy really is expansionary when an economy is as depressed as ours, then there is the added bonus of a significant multiplier on top of the added long-run growth.

So deficits should be bigger.  Now, in the middle of a deeply depressed economy, is not the time to pay down deficits.  That time will come, when interest rates are higher, we don't have so much excess capacity and so much unemployment.  At such a time increased government spending would in fact displace private investment and drive interest rates up.  But that time is not today and won't be in the next two or three years, at least.

I'm saddened and frustrated by the massive and needless suffering taking place.  And worse, by the evening news and our fear-driven leaders who can't even get the basic econ 101 right, and thereby strive to deepen and widen the sea of needless misery.

Update: I realize all this has been said before, perhaps more eloquently, by many others.  Just adding another small voice in the wilderness....


  1. I’m with you that 2.6% seems awfully cheap, but what is the right way to frame the question of how much the government should spend, and how much of that should be financed through debt rather than tax revenues? Surely government spending has diminishing marginal returns (otherwise public spending should be infinite!), and it’s much less obvious than in the private sector how to measure where marginal cost starts to outweigh marginal benefit.

    And aren’t entitlements (rather than current expenditures) the real problem anyway?

  2. R:

    Yeah, the long-run problem really is about entitlements.

    And we probably are spending too much on health care, in general, not just in entitlements. But then government health care costs are growing at a much slower rate (albeit still very fast) than private health care costs. We'd be way more efficient to increase the government scope of health care.

    I think it's also clear that we spend too little on infrastructure and education. Countless studies show this. We're nowhere near the point of diminishing marginal returns.

    So, aside from the recession, stimulus and all that, I think we can easily justify higher government spending today.

    In the long run, we need to control health care costs. The most sensible way to do that is to stop government-paid insurance for the most expensive procedures that tend to extend life very little or not at all. You know, death panels and all that... If people want to pay a million dollars so grandpa can live another week in the hospital, let them do it. But it's hard to justify Medicare picking up the tab.

    Also, we'll need more tax revenues. We can do that a lot of different ways. I'm a little partial to a consumption tax (national sales tax). That's something some conservative economists like too. Robert Hall is advocating we more toward more consumption taxes and away from income taxes. If we announce this in advance and do it gradually, it can help stimulate the economy, too!

    In the short to medium run the best thing we can do for the deficit is get the economy growing again. And that, ironically, probably means not worrying about deficits right now.


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