Tackling long-term debt is not the nation’s most urgent fiscal problem. Getting a full head of steam behind the recovery must be the priority, and for that, we’ll have to tolerate high annual deficits for a while.
The folks who make and write about economic policy must have very bad memories.
Otherwise they would know that the large deficits we are now seeing are the result of the collapse of the housing bubble and will eventually come under control.
In 2007, before the bubble burst, the deficit was just 1.7 percent of the nation’s economic output, or gross domestic product, and the ratio of debt to GDP was falling. The debt-to-GDP ratio was projected to continue to decline even if President George W. Bush’s tax cuts were extended past 2010.
This all changed with the collapse of $8 trillion in wealth related to housing. This collapse eliminated more than $1.2 trillion in annual construction and consumption demand. Construction plummeted because of an enormous oversupply of housing from the boom years. Consumption fell because the bubble wealth that had sustained it disappeared.
The private sector was not going to replace this demand quickly. This was the rationale for the tax cuts and increased spending that led to large deficits.
The resulting deficits will be necessary to sustain employment and growth until private-sector demand picks up. Once that happens, deficits will be at a more manageable level. We will still need some additional tax revenue – for example the money from taking back the Bush-era tax cuts on the wealthy – for infrastructure, education, and research and development.
We will also have to fix our broken private health-care system to ensure that Medicare and Medicaid are affordable in the long term. However, the immediate issue of the deficit is simply a question of replacing the demand lost from the collapse of the housing bubble and getting the economy on its feet.
Dean Baker is an economist and a codirector of the Center for Economic and Policy Research.
