A comment on the CBO Budget and Economic Outlook paper

It’s taken me a few days to graze through the new CBO Budget and Economic Outlook that came out last Tuesday.  I was a bit disappointed, because the budget impact of extending the Bush tax cuts was big, and I had discounted that a bit in my last post.   So the budget forecast was worse than I had hoped---but still, no great cataclysms were forecast for the next decade.  On the contrary, the forecast is that the Treasury debt held by the public will decline a bit as a share of GDP after 2015 (and grow again after 2018, but forecasts that far out are, shall we say, subject to revision as the date approaches.)   The forecast for the deficit this year is $845 billion, the first deficit under a trillion dollars since the plunge into recession---the first since the final Bush budget---and for declining budget deficits for the next few years as the economy slowly, painfully recovers.  The deficit will be 2.4% of GDP in 2015, according to their figures and will remain under 3% until 2019.  So nothing in the report requires an immediate panic, and nothing requires that we decimate our economy in a frantic effort to balance the budget right now.  If anything, in my opinion and the opinion of many others, good investments (ie, in new infrastructure and repair of existing infrastructure) could increase growth toward the end of the decade and for decades after that, and could therefore reduce the debt as a share of GDP.

Here are links to comments on the new Outlook document by Paul Krugman and Jared Bernstein.  Krugman presents a pretty lucid graph from the report showing that the big factor in rising deficits at the end of the decade is not anything we are likely to be able to fix between now and then no matter how much we cut budgets or increase taxes: it is increasing interest rates on the government debt we already have.  Health care programs are part of it too, but Social Security is just not a factor, and other programs are assumed (under current law) to decline. 

But Bernstein noticed the thing that bothered me the most in the report.  I left a comment on his blog citing these two quotes from the report.  From the first chapter, on page 7:

“Because federal borrowing generally reduces national saving, the stock of assets, such as equipment and structures, will be smaller and aggregate wages will be less than if the debt were lower…Moreover, such a large debt poses an increased risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.”

And from the second chapter, on page 47:

“CBO estimates that greater federal borrowing under current law…would reduce the size of the capital stock. That reduction would occur because, by CBO estimates, federal borrowing would take up a larger share of the saving potentially available for private investment.”

The last line in the first quote seems to be a straightforward statement of belief in the Confidence Fairy , that magical creature that has done such a great job of restoring prosperity in Europe in the last few years.  And federal borrowing reduces national saving?  It certainly does not reduce private savings.  Here’s a chart of net private and government savings as recorded in the National Income and Product Accounts from the Bureau of Economic Analysis database:

Notice how the two lines seem to almost mirror each other?  Increases in government deficits (or, to say the same thing, decreases in government surpluses) seem to be associated in time, at least, with increases, not decreases, in private savings.  Which, as I’ve pointed out before, is what you would expect from the accounting equations.  

On the issue raised in the second quote, Bernstein said this:

“The usual argument here—the thinking embedded in the CBO quote above—has to do with public borrowing crowding out private borrowing and thus leading to higher interest rates for scarce investment capital.  It’s actually hard to find convincing evidence for that relationship even in good times, but it’s impossible to find it right now, for obvious reasons.  In recessions, deficit spending goes up while weak demand and Fed Reserve actions push interest rates down.”

Now, these quotes that seem to endorse crowding-out and the Confidence Fairy are only a couple of lines in a long report, and the report as a whole is---well, it’s the Congressional Budget Office report on the Budget and Economic Outlook.  It’s the standard against which other forecasts will be judged, and which every other forecast will cite, at least until their next revision comes out in August.  It’s the CBO’s job to be non-ideological, non-partisan, plain economists doing their best to provide fair analysis, and they do it very very well, which is why both Republicans and Democrats cite them endlessly in political argument.     Still, these side comments in the report mean something.  Maybe they mean that even economists at the CBO aren’t immune to influence from all the Washington insiders they know, from the important people who say these groundless things about Confidence Fairies and crowding out as though they were certainties, and who never question them.