The Country Has Sustained Much Greater Debt Burdens in the Past

Dean Baker
Los Angeles Times, October 8, 2009

[This is the second piece in a debate with Maya MacGuineas of the New American Foundation about budget deficits, spending, and the recession. See it in its full context here. The first piece can be found here.]

Maya, it is always dangerous to make policy based on the financial markets' perceptions of good policy – or, even worse, our perceptions of the financial markets' perceptions. Remember, the big actors in financial markets were just fine with both the stock market and housing bubbles. They would have wrecked their banks, in addition to wrecking the economy, had they not been able to tap the U.S. Treasury Department and Federal Reserve for hundreds of billions of dollars in below-market loans. We should be trying to design good policy, not guessing what goes through the minds of the wizards of Wall Street.

Because we are still far below levels of debt that the United States has sustained in the past, we should not worry that the country cannot support its debt burden. The peak was reached after World War II, when the debt was more than 110% of the U.S. gross domestic product, or $15.5 trillion in today's economy. Far from being a burden on future generations, we enjoyed rapid rises in living standards over the three decades that followed World War II.

It is also important to note that the Wall Street horror story of a decline in the value of the dollar in world currency markets is actually a necessary and desirable outcome. The overvalued dollar has made our exports uncompetitive and has led to a flood of cheap imports. In fact, it was a main cause of the imbalances that fueled the housing bubble.

If the dollar dropped in value against the Chinese yuan and other major currencies, it would lead to a reduction in our trade deficit. In fact, such a decline is actually an official policy goal of the Obama administration and was one for the Bush administration. Both demanded that China stop "manipulating" its currency by keeping the yuan undervalued relative to the dollar.

It is important to clarify an important misconception about the stimulus and where the economy sits right now. It is often said that most of the stimulus has not yet been spent. This is true, but it is misleading.

Think of it this way: Suppose my rich uncle tells me that he will give me $2,400 over the next two years in payments of $100 a month. At first I may not change my spending much, maybe because I'm not sure that my uncle will keep his promise. After three or four months, I would probably recognize that the money will keep coming and would adjust my spending accordingly.

My monthly spending would reach its peak around, say, the sixth month, even though I will have received only one-fourth of the total money promised. This is where we stand now with the stimulus; we have already gotten pretty much the full lift from the package. The stimulus will remain in place through 2010, but it will be providing no additional boost in demand in future quarters compared to what it has already done, just as my spending will not increase in the seventh month that I get my uncle's check compared to the sixth.

The unemployment projections from the Congressional Budget Office fully incorporate the predicted effect of the stimulus. If we say that it's OK to start reducing the deficit in 2011, when the CBO projects a 9.1% unemployment rate, then we are saying that this unemployment rate is fine and we can even live with a higher one. Even for 2012, the CBO is projecting a 7.7% unemployment rate, a level far higher than we ever reached in the last recession, and also far higher than the level that prompted the first stimulus in the winter of 2008. This view might be old-fashioned, but ordinary workers and their children should not be forced to suffer because of the incompetence of the geniuses who manage the economy and run Wall Street banks.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.