Do budget deficits affect long-term interest rates? U.S. federal budget deficits are back big time. What will be their long-term consequences? Seven big thinkers enter the ring, gloves up

International Economy, The, Summer, 2003

Politically, this argument demonstrates that what is behind the Administration's deficit embrace is an ideological and not an economic motivation. What we are seeing here is a political bait-and-switch operation.

The highest priority of the right wing has been and is a series of large and continuous tax cuts greatly deepening our national debt. But as these tax cuts take effect they will fall ardently back in love with balanced budgets--indeed, bizarrely, the Republicans on the House Judiciary Committee are now preparing a Constitutional amendment to require the budget to be balanced--and use the large deficits they are creating as arguments against government programs in education, housing, environmental clean-up and transportation. Most importantly, these large deficits will be crucial to the effort to cut back Medicare and Social Security.

A substantial privatization of both of these successful and popular social programs is high on the conservatives' agenda, and the reluctance to embrace that goal on the part of those who benefit from them is an obstacle. Thus, the role of deficits: creating a situation in which a scarcity of resources forces far more fundamental changes in both Social Security and Medicare than would otherwise be achievable.

The movie that the conservatives are now producing--"How I Learned To Stop Worrying and Love the Deficit"--ends like its predecessor with a huge explosion, but in this script, it is the notion that the public sector has an important role to play in approving the quality of our lives that gets blown up.

JACK KEMP

Co-Director, Empower America

"Nor shall the argument seem strange, that taxation would be so high as to defeat its object and that given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget."

--John Maynard Keynes

Contrary to the above admonition of John Maynard Keynes, the notion that deficits cause interest rates to rise and therefore slow economic growth--Rubinomics, more in the tradition of Hoover economics--has now become the mantra of many of those opposed to President Bush's proposal to pass incentive-based tax rate reductions. This new conventional wisdom is best evidenced in the February 11, 2003, edition of the New York Times, where no less than ten Nobel Laureates and a host of left-leaning economists took out a full-page advertisement to bemoan President Bush's tax cut proposal. In particular, these economists noted that, "Passing the tax cuts will worsen the long-term budget outlook, adding to the nation's projected chronic deficits." The theory that deficits lead inexorably to higher interest rates and, as a result, lower economic growth is at the heart of the "deficit hawk" opposition to President Bush's tax rate reduction plan.

There is little empirical data to back up the theory that deficits lead ipso facto to higher interest rates. As Larry Kudlow points out in a recent article, "In bondland, long-term interest rates continue to decline. If a lower dollar and rising budget deficits are so bad, why are Treasury rates at 45-year lows?" For even more dramatic and long-term evidence, simply observe the Japanese economy where the debt is greater than 130 percent of GDP while interest rates remain near zero--not coincidentally this debt was largely accumulated in the last ten years while pursuing a decade of government-driven "economic stimulus" packages advocated by many of the same economists signing on to the New York Times advertisement.