Why Balance the Budget?
I mentioned in the previous post that Republicans have pledged to craft a plan that balances the budget in ten years. As a political matter, it’s easy to see why they would do this—Americans like the idea of a balanced budget. As an economic issue, however, the question is less clear. Here’s Matthew Yglesias asking if there’s anything—anything at all—that we gain from having a balanced budget:
The budget will, presumably, cut spending down to a level that conservatives think is appropriate. Say that sums up to 18 percent of GDP. Well if you’re spending 18 percent of GDP and 18 percent of GDP is the right amount to spend, then why is it better to raise 18 percent of GDP in taxes rather than raise 16 percent and borrow the rest?
Is it because a 2 percent of GDP budget deficit would be inflationary? Is it because an inflation-targeting central bank faced with a 2 percent of GDP budget deficit would be forced to peg short-term interest rates at a high level? What’s the problem, exactly, that the budget balancing solves once we’ve stipulated that spending has been cut to an appropriate level?
The fact of the matter is that the United States can run deficits indefinitely. Of course, this doesn’t mean $1 trillion deficits as far as they eye can see; as Josh Barro noted a few years back in a post for the National Review, the key to budget sustainability isn’t balance, it is “it is making sure that the public debt does not grow faster (over the long term) than the economy.” Deficits of the current size—if stretched out over the long-term, across business cycles—are detrimental to the economy. But moderate deficits are fine, as long as the economy grows at a healthy clip. Barro explains:
Let’s say that your structural budget gap is 2 percent of GDP, meaning that will be your average budget deficit, though it will be higher in recessions and lower in expansions. And let’s say that your long term rate of nominal GDP growth is 4 percent. Maintaining those two trends will ultimately cause your debt to GDP ratio to stabilize at 50 percent—in any given year, the economy will be twice as large as the public debt and will grow by twice as many dollars.
The ideal debt to GDP ratio is debatable, but 50 percent is certainly acceptable and sustainable.
It all comes down to this: The government isn’t a household. It doesn’t need to maintain a balanced budget, and on the whole, it probably shouldn’t. After all, the goal of public policy isn’t to turn an accounting trick—which, in the end, is what a balanced budget amounts to—it’s to solve national problems and foster economic growth. Insofar that cries for a balanced budget gets in the way of that, we should ignore them.