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1982 AEI Economist 1 (1982)

handle is hein.amenin/aeieco1982 and id is 1 raw text is: the a economist Ameycan Enterprise Institute for Public Policy Research January 1982 Why Deficits Matter Herbert Stein On December 8, 1981, the American Enterprise Institute held a seminar on economic policy. On the same day, the newspapers were filled with stories, emanating from the Executive Office, that the federal budget deficit would be over $100 billion in the current year-fiscal 1982-and would rise to about $160 billion by fiscal 1984. Much of the discussion at the seminar naturally revolved around the implication of these numbers. Press reports of the seminar, which were unusually numerous for such an event, tended to give the impression that the debate was about whether deficits mattered, with administration economists taking the position that they do not matter and some others that they do. This interpre- tation, of course, made the story unusually inter- esting in view of the president's long-time devotion to the idea that the budget should be balanced. But, in fact, that was not an accurate report of what happened. No one present maintained that deficits do not matter. It would be odd for an economist to maintain that. Economists work with a general equilibrium model of the economic system in which everything depends on everything else. In the analogy of physics, one atom cannot move without moving all the other atoms of the universe in some degree. The question is not whether deficits matter, but how and why they matter and what should be done about the fact that they matter. This question was discussed at the seminar. I propose here to summarize that discussion, quot- ing some of the participants at some points but not trying to give a complete and balanced picture of the position of any one, since the seminar did not provide opportunity for that. This report of the discussion will be rounded out in places with observations of my own. I will take in order five kinds of effects deficits might have that would be reasons for concern- The question is not whether deficits matter, but how and why they matter and what should be done about the fact that they matter. effects on inflation, on recovery from the recession, on private investment, on the distribution of tax burdens between the present and the future, and on fiscal discipline. Deficits and Inflation In recent years inflation has been the most serious evil commonly attributed to deficits, and deficits have commonly been considered the main cause of inflation. Ronald Reagan has often made this con- nection, although less often since he became pres- ident than he did earlier. The logic of the con- nection is usually assumed to be obvious. If the government spends more than it takes in, it adds its own demand for goods to the undiminished private demand and so raises total demand, increasing the demand for goods relative to their supply and so forcing prices up. This thinking leads to the difficulty of where the government gets the money it needs to operate when it runs a deficit. If the The AEI Economist / 1

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