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What Size Fiscal Deficits for the United States?

Monday, November 21, 2016 13:41
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Olivier Blanchard:

What Size Fiscal Deficits for the United States: The US government can borrow at interest rates very close to zero. Surely the long-term benefits of public investment are greater than zero. Isn’t it obvious that the case for more government borrowing is overwhelming…?

The answer? Not so fast.

True, US government borrowing costs are very low. …

True, if the economy were operating far below potential, the case for large deficits would then be a very strong one. Surely public investment should be increased and financed by debt under such circumstances. …

So is it an open and shut case? No.

The US economy is operating close to its potential…, we are close to full employment. …

This implies that if US policymakers wanted to avoid an overheating economy, greater public spending would have to be offset by a reduction in some component of private spending (which, presumably, would be achieved by an increase in interest rates by the Federal Reserve). To the extent that the reduction came from private investment…, private capital that would be crowded out. Given the poor state of public capital in the United States, the case is still there for an increase in public spending, and a corresponding higher deficit, but it is clearly weaker.

Is there a case for doing more? The answer is a qualified yes.

There is a case for temporarily overheating the US economy. The reason goes under the ugly name of “hysteresis”…, the notion that the long period of low growth and high unemployment has led to some permanent damage, which can be partly undone by a period of overheating of the economy. The most obvious case here is labor force participation… A period of very low unemployment may lead some of them to come back into the labor force. …

What is the bottom line? There is no case … for all-out fiscal deficits. But there is a case for a fiscal expansion, based on carefully targeted public investment. Two remarks are needed here. Maintenance of existing infrastructure…, which has been badly neglected, may be less glamorous and less politically attractive than brand-new projects, but it is where the government is likely to get the best bang for its buck. Public-private partnerships, which have been mentioned by the Trump program, may not be the right tool: By aiming at projects that can at least partly pay for themselves financially, they may generate the wrong kind of public investment. Maintenance and the most useful public projects may have high social returns, but they are likely to have low financial returns. 

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