Weber State College Comment, April 1989. Page 4 by Sarah E. Tinkler Assistant Professor of Economics ~eficit Deficit” _wItDeficit De® -..witVeticitDeficitDeficit Deficitr. efi~ ne -**Meficit DeficitDe _weficit Deficit” ae scit DeficitD _-wenenwericitDeticit D-* ..~wweticit DeficitDeficitDeficit™- ~ ~DeficitDefi-** ™-* etficitDeficit” wit LJOCMCilLevoc: eficitDeficitDeticit DeficitDefir-*~ “=~§#DeficitDefic*t ™-* _ yeitDeticitD- eduction of this country’s $300 billion annual federal deficit is seen by most as vital for the nation’s long-term economic growth, but the how and when of reduction, as well as the nearfuture effects of the deficit are less clear. The more pessimistic among economists have predicted doom from mounting U.S. deficits for some years, but so far, with the important exception of the foreign sector. the pessimists have been wrong. The U.S. is currently enjoying the longest recovery in post-war history. However, the fact that substantial domestic problems with the deficit have not yet occurred is not a justification for complacency about the future. The economy has showed some signs of strain — for example, the stock market crash of October, 1987 was partially the result of financiai market jitters about future economic prospects. The issue of the impact of the federal deficit on individual consumers is fraught with complexities, but one thing is clear: There has been an unprecedented increase in the size of the government’s annual deficit over the last eight years. This simply means that the gap between what the government spends and what it collects in tax revenue has been growing. In 1980 the federal deficit stood at two percent of the Gross National Product. By 1983 it had risen to almost six percent — the largest federal deficit in history. The deficit has started to fall—it is already half what it was in 1983—but it is still huge by historic standards. Leaving aside the moral objections to large deficits, what are the economic implications for individuals subjected to this federal spending spree? Debt creation The problems created by federal deficits are not entirely analogous to those created by individual debt. If a family continuously spends more than it earns (which means It is operating at a deficit and thus adding to its stock of debt) eventually it will be forced into bankruptcy or at least into a period of belt-tightening until the existing debt is paid off. The U.S. government is not so constrained. It has the ability to tap the huge savings pool of America and the rest of the world. It does so primarily by issuing treas‘ury bills. When a government wishes to increase its cash flow it sells treasury bills to National deficit: Shadows of inflation investors both in and out of the country with the promise of future interest payments. Since the U.S. is never likely to default on its loans, and since there is a seemingly endless supply of investors willing to hold its bonds, we must look to other factors to evaluate whether current nationai deficits are “too large.” All economists agree that a number of problem areas mighi indicate whether the current level of deficit spending will “hurt economic’prosperity. Interest rates To what extent is government debt “crowding out” private debt? To sell treasury bills the government must offer an attractive interest rate to the investor. Unfortunately, all interest rates are connected, so the raising of interest rates for treasury bills also affects rates on all money. Higher interest rates reduce the likelihood that private corporations will borrow for growth, in effect crowding them out of the borrowing market. Firms will reduce investments in new plants which threatens job creation, labor productivity, and thus, future improvements in the standard of living. If “crowding out” becomes a serious problem the long-term health of the American economy is threatened. The recent rise in interest rates is a cause for concern here. High interest rates also mean expensive mortgages, putting home ownership out of the reach of some Americans and making it more expensive for those who can still afford it. At the same time, America’s addiction to consumer credit becomes more expensive. Inflation Is the deficit causing inflationary pressure in the American economy? When unempioyment is high an increased demand for goods and services from government-financed agencies, such as the detense department, or by the recipients of government payments such as social security beneficiaries, can be met by increased production of goods as people return to the work force. But low unemployment limits the ability of the economy to meet additional demands, and results instead in higher prices. During the early Reagan years fear of inflation was muted because unemployment was fairly high. Now that unemployment is low the prospect of accelerating inflation needs to be taken seriously. Inflation brings with it economic uncertainty—which is itself a damper on investment. Inflation also raises the possibility of social and industrial unrest, and causes problems for people on fixed incomes, such as the retired, who see an erosion of their standard of living. ~Pressures from:the deficit are-just-starting to show in this area. Last quarter inflation rose to the highest mark it’s been in a long time. Foreign trade Is the deficit harming America’s position in the world economy since it is financed in large part by foreign funds— particularly Japanese? There is good reason to blame the current U.S. trade deficit on the expanded federal deficit. During the Reagan years a large inflow of foreign money, caused in part by higher U.S. interest rates that were themselves a result of deficit spending, caused the dollar to rise in value and so harmed the business of America’s exporters as their products became uncompeti- Most deficit-related maladies are not now realities, but the crucial variable for the future must be the prospect for sustained economic growth. tive on world markets. . The initial inflow of foreign funds to buy U.S. bonds resulted in a temporary increase in available cash, but now that interest payments are due there is a steady trickle of funds leaving the country. The United States must make up that loss in the export of goods and services or the nation will experience a drain on the economy. There is no doubt that the federal deficit is largely responsible for the trade deficit and its problems. The dollar is now much weaker. That weakness partly reflects administration concerns about the size of the trade deficit. The government has been following a strategy of encouraging the dollar to fall against other currencies to help reduce the size of the trade deficit. Right now the weak dollar helps U.S. exporters and makes American investments seem very attractive to investors shopping in yen and deutschmarks. [It’s interesting to note that in some areas of the U.S. there is increasing concern about large real estate purchases by foreign investors. Of course foreigners are also making many less visible investments in other sectors of the economy. It is ironic that Americans now fear control of their economy by foreign money interests in the same way that Europeans and others feared U.S. control in the years immediately following World War I/.] But a weak dollar also makes such vital imports as foreign oil more expensive. This can create inflationary pressure because the cost of imported raw materials feeds directly into the cost of final goods and services. The end result is that the federal deficit can have serious ramifications far away from the rather abstract world of government finance. — The potential for problems resulting from large federal deficits is clear, but are we actually experiencing these problems? If not, are we in for deficit-related trouble in the future? Future economic outlook Most deficit-related maladies, again with the exception of the trade deficit, are not now realities, but the crucial variable for the future must be the prospect for sustained economic growth. If the Bush administration is able to freeze expenditures at the existing level and maintain tax rates then strong economic growth will enable the economy to “grow into” the deficit—and most of the problems mentioned will have minimal impact. On the other hand, if economic growth is sluggish, severe problems arising from the deficit become likely. Many analysts feel that the current administration’s forecasts of future economic growth are far too optimistic. Any shortfall below the Bush estimates will seriously undermine his ability to pull off deficit reduction. Some estimates of future growth even project expanding, not contracting deficits. If growth falls short then the deficit will not simply disappear, and the American economy will have to brace itself for the reemergence of economic problems.