Reality Check Ahead on Deficit Spending

George Orwell has a famous insight from his 1945 work Notes on Nationalism.

“One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.”

Most people run into this insight in a paraphrased form.

“There are some ideas so absurd that only an intellectual could believe them.”

That’s not something Orwell said or wrote, but is often attributed to him because of the power of his insight.

Orwell’s insight comes to mind because of the Biden-Harris administration’s implicit adoption of what’s called Modern Monetary Theory, which holds that “deficits no longer matter”.

The Origin of an Absurd Idea

That absurd idea didn’t come from nowhere. As you might suspect from the introduction, it came from academia. It specifically comes from 1995 paper by three highly influential economists. Among them, Greg Mankiw, who chaired President George H.W. Bush’s Council of Economic advisers, Doug Elmendorf, the former director of the Congressional Budget Office, and Laurence Ball, a professor at Johns Hopkins University. The title of the paper is “The Deficit Gamble”.

The three argued that so long as the nation’s economic growth rate is higher than the interest rates it pays on the national debt, it can run deficits and roll over the unpaid portion of debt indefinitely. But there’s a potentially costly risk to Americans attached to what they described as a “Ponzi gamble”. Running permanent deficits mean a 10-20% chance of a substantial increase in taxes to pay for the never-ending deficit spending.

New Uncertainty as Theory Meets Reality

Now, faced with the Biden-Harris administration’s proposed spending plans in the current pandemic-influenced economic environment, Mankiw is worried the U.S. risks of being on the losing end of his Ponzi gamble:

Mankiw said now, though, both the key variables that would allow the deficit gamble to work—low interest rates and fast economic growth—are uncertain and the former may be artificially low because of recent changes in the economy.

Short-term, the economy is poised to continue a strong rebound from the COVID-19-induced slowdown in 2020, aided by pent-up consumer demand and the passage of the $1.9 trillion stimulus package. But Mankiw said longer-term issues, like climate change, productivity and the pace of technology advancement, make it unclear how strong growth will be ahead.

Mankiw says interest rates may be being held artificially low because the market power of companies is so great now it resembles that held by monopolies, a theory he has explored with Ball in a new paper.

The Federal Reserve approaches monopoly status in funding the U.S. government’s deficit spending. Its current bond-buying policies artificially lower interest rates.

Losing the Ponzi Gamble

Meanwhile, in the real world, President Biden is sending a signal to both Americans and economists who argue deficits no longer matter. He will guarantee they lose the Ponzi gamble.

“Here’s what the American Families Plan doesn’t do: It doesn’t add a single penny to our deficit.”
—President Biden, remarks at Tidewater Community College, May 3

“That’s why the American Family Plan does four things, and we pay for it all. One, without raising the deficit.”
—Biden, in a political rally in Duluth, Ga., April 29

“So how do we pay for my jobs and family plan? I made it clear, we can do without increasing the deficit.”
—Biden, remarks during an address to Congress, April 28

To accomplish that outcome, the Biden-Harris administration proposes hiking many taxes. By doing so, President Biden rejects the main selling point of his 2020 campaign’s economics policy. He is issuing the academics a reality check by proving deficits do matter.

Craig Eyermann is a Research Fellow at the Independent Institute.
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