Good Deficit / Bad Deficit

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Although some fiscal hawks might not be thrilled to admit it, we need big budget deficits today. When the economy is underperforming, large tax cuts and spending increases can allow the government to compensate for drops in consumer spending.
 
This logic, often branded “Keynesianism,” has caused us to enact considerable amounts of “economic stimulus” which has contributed to our $1.85 trillion deficit. Although necessary for now, CBO Director Doug Elmendorf has pointed out that this borrowing comes with considerable risk:
 
“During a recession there is an inherent tension between fiscal policy goals for the near term and for the long term … Budget deficits tend to slow economic growth in the long term if they are allowed to persist, because they tend to reduce capital accumulation and the upward trend in the economy’s capacity to produce ...
 
Increases in spending and decreases in taxes that are intended to be temporary may be difficult to reverse later. Moreover, even if taxes and noninterest spending return to their baseline levels, the additional debt service from the period of larger deficits will—unless offset by greater fiscal discipline later—crowd out some amount of future economic growth … In addition to their negative long-term effects, policies that substantially worsen the fiscal outlook can have negative short-term effects as well.
 
The nation currently benefits greatly from the fact that investors worldwide consider U.S. Treasury securities a safe haven in times of trouble. That tendency provides an important advantage for the United States in times of crisis, helping to increase liquidity and decrease interest rates. If investors lost confidence in the government’s debt as a safe haven because of deterioration in the long-term fiscal outlook, the U.S. economy would lose that advantage, perhaps permanently.”
 
My colleague, Anne Vorce, has written an excellent paper parsing out the “good deficit” from the “bad deficit” as part of CRFB’s Fiscal Roadmap Project.