Why the US won’t reduce the budget deficit – 10/10/2023 – Paul Krugman

Amid terrible events abroad and the takeover of the Republican Party by agents of chaos, the United States economy has delivered a lot of good news. All indications are that real GDP is still growing rapidly and we are adding jobs at an extraordinary pace, even as inflation continues to fall.

However, there is one part of the economic picture that is worrying — long-term interest rates have risen sharply since the beginning of 2002, especially in the last six months.

This rise in long-term interest rates is problematic in several ways. It’s not a crisis, at least not yet. But in a better world, we would be taking steps to lower interest rates sustainably. In particular, now would be a good time to control budget deficits.

However, the chances of serious action on the deficit anytime soon are close to zero. And it’s important to understand why.

First, why are high interest rates a problem? So far, there is no indication that they are about to cause a recession. In fact, the economy’s resilience in the face of higher rates is probably the main reason rates have risen so much.

That is, investors appear to be giving up, concluding that the “short-term real interest rate expected to prevail when an economy is at full strength and inflation is stable” has risen sharply.

If that happens, the Federal Reserve will have to keep short-term interest rates, which it more or less controls, high for a long time to prevent a resurgence of inflation. And the prospect of high short-term rates for as long as anyone can see is causing investors to raise long-term rates.

There are other possible explanations for the rise in rates, ranging from simple supply and demand — the government is selling a lot of debt now, and the Fed is no longer buying it — to investor psychology. But either way, there is no clear case that rising rates will harm the economy in the short term.

However, there are long-term concerns. One is that higher borrowing costs could make public debt less sustainable. I still don’t think we’re going into a fiscal crisis anytime soon — and neither do the markets.

If investors were truly worried about U.S. solvency, they would likely expect higher inflation as the federal government turns to the printing press to pay some of its bills.

But we can infer market inflation expectations by looking at the break-even rate, the difference between inflation-protected bonds and regular bonds. Expected inflation has remained stable and does not explain any of the spikes in interest rates.

Furthermore, if investors were worried about US solvency, we would expect the dollar to fall relative to other currencies; in fact, he went up.

But even if there is no immediate crisis, high interest rates will almost certainly undermine private investment, harming our long-term prospects. I am especially concerned about the effects of high taxes on investments in renewable energy, which are of existential importance.

So it would be really good to lower interest rates again. Unfortunately, the Federal Reserve cannot simply reverse its policy of raising rates to limit inflation. Although the inflation news has been extremely encouraging, the US economy appears to be very hot, and cutting rates could still cause it to overheat, sending inflation soaring again.

To make room for lower interest rates, then, we would need to take some of the heat out of the economy in another way — most obviously, by reducing the budget deficit, which is too high for an economy close to full employment.

Now, some readers may be surprised to hear me say this. After all, I spent much of the last 15 years criticizing the deficit alarmists who hijacked the economic debate after the 2008 financial crisis, diverting it from the need to restore full employment.

The turn to fiscal austerity caused by this shift in focus has caused immense damage, leading to millions of lost jobs and neglect of important public investments.

But there’s a big difference between being obsessed with the budget deficit in, say, early 2013, and believing we could have a smaller deficit now. At that time, the interest rate on inflation-protected bonds was negative, so investors were, in effect, paying the federal government to take their money. Now, this rate is 2.4%. Therefore, it makes much more sense to worry about debt now.

Furthermore, at that time, unemployment was still high — close to 8% — so government spending was not competing with private spending for scarce resources. Now, unemployment is below 4%, so competition is a real concern.

So while we don’t need to panic about budget deficits, a smaller deficit would actually help economic management now.

But that won’t happen. Why? If you listen to Republican politicians, you might think that deficit reduction is easy — just cut unnecessary government spending, a category that Maga adherents [movimento Make America Great Again, que apoia o ex-presidente Donald Trump] they think it includes aid to Ukraine in the fight against Russia’s invasion. And most voters say the government spends too much in general.

But ask voters about specific spending and there’s almost nothing they want to cut. The bottom line, as always, is that the federal government is essentially an insurance company with an army.

Social Security, healthcare, and other social security programs accounted for the majority of government spending in fiscal year 2023. Add in military spending and interest payments, and what’s left—NDD, for “nondefense discretionary spending”— is a small slice of the total. Furthermore, the NDD has been squeezed by past austerity. Therefore, there is no possibility of major spending cuts unless we cut extremely popular programs.

And is this really desirable? The United States has a much weaker social safety net than other advanced economies, reflecting low government social spending.

Our weak social safety net is at least part of the reason we have so much poverty and Americans are, quite frankly, dying much younger than their counterparts abroad. Why make it even weaker?

But what about the deficit? Well, there’s an obvious answer: raise more taxes. In fact, the United States is a nation with a very low tax burden compared to Europe.

The problem is obvious. Conservatives always want to cut taxes, especially for the rich, even though polls suggest that most Americans believe the rich pay too little. Republicans are even trying to defund the IRS [a Receita Federal dos EUA] of the resources needed to combat tax evasion by the rich.

And while Democrats are at least willing to tax the rich, that alone won’t be enough (although it will help). And they are unwilling to take on the political heat by proposing tax increases for the middle class.

The point is that the economics of deficit reduction are simple. It can be achieved both by reducing social benefits and increasing taxes. Given that the United States has weak social spending compared to other countries, taxes are the most plausible route. But I see no plausible policy path to a tax increase that would significantly reduce the deficit.

So serious deficit reduction, a bad idea a decade ago, is a good idea now. But I don’t see how to make it a reality.