The NYT has a lengthy front page article telling readers that President Obama wants to structure his health care reform package in a way that does not raise the deficit. It cites Robert Greenstein, the head of the Center for Budget and Policy Priorities (who is not an economist), saying that: "There’s a concern that if Congress were to pass a big health care bill that was heavily deficit-financed, financial markets could react negatively, with higher interest rates that could deepen the recession.” Actually, it is almost inconceivable that any possible impact of a boost to the deficit from health care reform would have such a large effect on interest rates as to hurt the economy enough to offset the help that any increase in the deficit would provide to the economy. It is implausible that President Obama's advisors actually believe this. It is plausible that they believe that they could suffer political harm from raising the deficit, since many Republicans and media outlets like the Washington Post and Fox news will attack him for it. The NYT should have found an economist to explain the relationship between deficit spending and economic growth in the context of a severe downturn like the one we are currently experiencing. [For the record, it is perhaps worth explaining how higher interest rates, caused by larger deficits, could affect demand. There are three main channels. Higher interest rates have some impact on investment, but most research shows that this effect is very limited. Growth in demand is a far more important determinant of investment than interest rates. Higher interest rates can affect demand through consumption. If interest rates fall, then it is easier for people to borrow. In the current context, it is unlikely that lower interest rates will affect consumer spending to any great extent since most people have very limited ability to borrow as a result of the collapse of home prices and the loss of home equity. Also, almost everyone who has the ability to refinance has already done so. Higher interest rates can have an effect on housing demand, although the marginal economic impact of even fairly large changes in interest rates (1.0-2.0 percentage points) is likely to be limited. The demand generated by sales of existing homes is not very large so that even a large increase/decrease in sales will not have very much impact on the economy. With the enormous inventory of unsold homes, it is almost inconceivable that building will pick up appreciably in the next couple of years. Higher interest rates can raise the value of the dollar as foreign investors decide to hold more dollar-denominated assets. This would increase the trade deficit. However, the value of the dollar seems to be controlled far more by political decisions than market forces at the moment, so it is unlikely that it would rise much if the deficit grew. In short, it is difficult to identify a channel whereby a higher long-term deficit can have a substantial negative impact on demand in the near future.]
--Dean Baker
