Debt, Deficits, Secular Stagnation and the Which Way Is Up Problem in Economics

Photograph by Nathaniel St. Clair

The economy can have a problem of too much demand, leading to serious inflationary pressures. It can also have a problem of too little demand, leading to slow growth and unemployment. But can it have both at the same time?

Apparently, the leading lights in economic policy circles seem to think so. As I noted few days ago, back in the 1990s and 00s economists were almost universally warning of the bad effects of an aging population. The issue was that we would have too many retirees and too few workers to support them.

This meant a problem of excess demand. Since much of the money to support retirees comes from government programs for the elderly, like Social Security and Medicare, this meant we would see this show up as large government budget deficits, unless we had big tax increases to reduce demand.

In recent years, this view had largely been replaced with concerns over secular stagnation. This is a story where an aging population implies a slow-growing or shrinking labor force. This reduces the need for investment spending. The reduction in investment spending, coupled with other factors increasing saving, gives what Larry Summers referred to as a “savings glut.” This is a story of too little demand.

Okay, so it’s January of 2023, the Republicans are threatening to blow up the economy by not raising the debt ceiling, do we have a problem of too much demand or too little demand? Which way is up?

New York Times columnist Peter Coy weighed in firmly on the side of too much demand in a piece arguing we have to do something about deficits. He tells us:

“Unless you subscribe to modern monetary theory, which holds that deficits don’t matter unless they cause inflation, something has to be done, and soon. In textbook macroeconomics, higher debt leads to ‘higher real interest rates, greater interest payments to foreign investors, reduced business investment and lower consumer investment in durable goods,’ James Poterba, a public finance economist at the Massachusetts Institute of Technology, wrote for the Peter G. Peterson Foundation website in 2021.”

Okay, that’s a pretty clear statement of the too much demand story, coming from the foundation created by that great deficit hawk Peter Peterson. But, let’s take a look at Coy’s dismissive comment, “unless you subscribe to modern monetary theory,” and think about the issue at hand.[1]

I have never been a card-carrying member of Modern Monetary Theory (MMT), but I do take its arguments seriously. Let’s say that we run large budget deficits and have the Federal Reserve Board buy up much of the debt. To people who have been alive in the last 15 years, this policy goes under the name “quantitative easing.”

To my knowledge, none of the current or past members of the Fed consider themselves followers of MMT, but they basically followed an MMT prescription. They had the Fed buying up large amounts of debt to keep interest rates low and boost the economy.

The reason this is important is that we don’t get the exploding debt scare story that Coy, along with the Peter Peterson gang, are trying to push. When the Fed buys up bonds, guess who get the interest on the bonds?

That’s right folks, it goes to the Fed. And, the Fed refunds it to the Treasury. So, our crushing interest burden ends up being a simple accounting transaction where the Treasury essentially ends up paying interest to itself.

Okay, but how long can this go on for? The short answer is forever, the slightly longer answer is until we see a problem with inflation. This gets us back to the basic issue, are we worried that we have too much demand or too little demand.

If Larry Summers and other proponents of the secular stagnation view are correct, then we have very little reason to fear exploding budget deficits. Our major concern going forward will be too little demand. That means the Fed can do an awful lot of quantitative easing without causing any problems for the economy.

If that one is stretching people’s brains, let’s look to Japan. It has a debt-to-GDP ratio of 264 percent, the equivalent of a debt of more than $66 trillion in the United States. The interest rate on its long-term bonds is 0.35 percent. Its net interest payments on its government debt come to 0.3 percent of its GDP, compared to 1.7 percent in the United States. And, apart from a modest pandemic uptick, it has been struggling to raise its inflation rate to its central bank’s 2.0 percent target.

Long and short, if Larry Summers and the secular stagnation crew are correct, then the debt fears being pushed by many are unfounded. If, on the other hand, we are likely to run up against real and lasting supply constraints going forward, then too much spending or too little taxes, can be a problem.

What About Patent and Copyright Monopolies?

I just feel the need to ask, since no else ever does. Granting patent and copyright monopolies is one way the government pays people to do things. For some reason this obvious point is never mentioned in public discussions of debt and deficits.

If, for example, we were to decide to spend $100 billion more annually (we currently spend a bit more than $50 billion) on biomedical research, we would get an immediate chorus of “how are you going to pay for it?” from all knowledgeable policy types. However, if we tell the drug companies to spend $100 billion a year on research, and we will give you patent monopolies that allow you raise your prices by $100 billion annually above the free market price, no asks about how we pay for it. Of course, this is exactly what we do, but drug companies use these monopolies to raise their prices by somewhere around $400 billion annually.

Anyhow, it is more than a bit bizarre that almost everyone involved in budget debates has a clear conception of how we can impoverish our kids by imposing high taxes, but it seems none of them have given a second of thought to how high prices for drugs, medical equipment, computer software and a whole range of other items, due to government-granted monopolies, can be a burden.

As the saying goes, economists are not very good at economics.


[1] It’s also worth noting that the budget horror stories, past and present, project that health care spending will grow rapidly as a share of GDP. We actually have seen very limited increases in health care spending as a share of GDP, and since the pandemic, the health care spending share has actually fallen.

This first appeared on Dean Baker’s Beat the Press blog.  

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC.