(Bloomberg) --
As America’s fiscal deficit nears $1 trillion for the first time since the financial crisis, the House Budget Committee held a hearing on Wednesday seeking answers to a crucial question: Does it pose a clear and present danger to the economy?
Financial markets are saying, not really. The U.S. government can borrow 10-year money at about 1.8%, a historically low level, even after almost three years of widening budget shortfalls under President Donald Trump.
That’s encouraged Democrats aiming to challenge Trump in next year’s presidential election, especially Senators Bernie Sanders and Elizabeth Warren, to advance proposals that could widen it some more -- like Medicare for All and a Green New Deal.
In a pre-hearing report, the Democratic majority on the committee said economists are reconsidering the effects of large deficits, which were previously reckoned to push borrowing costs higher. “Interest rates have instead steadily declined to record lows,” it said.
More Room
At least two of the witnesses who testified Wednesday played a key part in the rethink. Olivier Blanchard, the former chief economist at the International Monetary Fund, argues that in a low-rates era there’s more room to invest or spend money on social programs without fear of inflation or flight from bond markets.
Blanchard said in his written testimony that there’s probably a case right now for paring deficits, at least before interest payments.
But he said that running an even bigger shortfall wouldn’t be “as irresponsible as it may sound,” and it should only be trimmed “at a speed which allows the Fed to offset the adverse effects.” Sharp moves toward a balanced budget would hurt the economy more than it would help, he said.
“Federal deficits and debt are not so scary. Neither is on an unsustainable path," was the opening salvo from Randall Wray, a professor at Bard College and one of the leading advocates of Modern Monetary Theory. The emerging school of thought says countries like the U.S., which borrow in their own currency, can pursue growth through deficit-spending so long as prices are under control.
Wray’s paper for the committee argued that MMT has never said deficits or debt don’t matter. But he said that they’re best viewed as outcomes of policies aimed at lifting the economy, rather than goals in themselves. When economists and lawmakers push for debt-reduction, he said, “MMT cautions that what we might be reducing is economic growth.”
MMT has won converts, but there’s been a backlash too -- with heavyweights from Federal Reserve Chair Jerome Powell to billionaire Warren Buffett denouncing it.
MMT on Trial?
As debate raged over MMT earlier this year, Republicans called for a hearing to condemn it as dangerous. Before Wednesday’s session, GOP lawmakers on the budget committee said they expected the doctrine to be a “central theme.”
They called MMT “a convenient theory” for politicians determined to spend trillions, and quoted Democrat-leaning economists including Paul Krugman and Larry Summers slamming the doctrine.
The Republican statement made no mention of the current U.S. deficit.
The Democratic version blamed GOP-backed “tax cuts for the wealthy,” saying they added to the budget shortfall without delivering a “meaningful boost” to investment or the economy.
Beyond that critique, the Democrats’ argument moved between portraying deficits as harmless or even potentially benign for now, and warning of the “critical and unsustainable fiscal challenge” the U.S. faces in the longer run, as the population gets older and the cost of health care rises.
Jared Bernstein, a former adviser to Vice President and 2020 contender Joe Biden, urged Congress in his testimony not to hold back from deficit-spending to support the economy next time a recession hits, even if debt levels are still high. “To do otherwise,” he said, “is to needlessly consign millions of Americans to economic losses that could be avoided.”
Bernstein said it’s often what policy makers think are the limits to spending, rather than any actual limits, that prevents an effective response. But he said it’s reasonable to be concerned about “persistent fiscal imbalances.”
The other witness called to the panel, Stanford professor John Taylor, was an outlier. He told lawmakers that reducing government debt and spending would “increase GDP immediately compared to a policy without spending restraint.” And he warned that MMT-type policies, including a deficit partly financed by the Fed, were tried in the 1970s and “the result was a terrible economy.”
Taylor noted that he’d testified at a 2015 panel entitled “Why Congress Must Balance the Budget.” In a sign of changing times, today’s hearing was titled: “Reexamining the Economic Costs of Debt.”
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