Deficits and Interest Rates: the Missing Link

True, the budget deficits piled up by the Bush adminstration and the porky Republican Congress are appalling, but they won't necessarily stall the economic recovery by boosting interest rates. In fact, one analysis finds no connection.

Economist Rik Hafer writes in the Wall Street Journal today that he showed a year ago that "the deficit/interest-rate link appears to be exactly the opposite of what the accepted wisdom suggests. That is, the chart showed little effect on interest rates from changes in the budget deficit."

He says the argument still holds, using projections from the Congressional Budget Office.

"The bets currently being placed in the market apparently put little weight on the projected deficits. And since the CBO's projected deficits assume that the Bush tax cuts will expire in 2011, the markets surely are aware of the possibility that the deficit in fact could be much greater than predicted," writes Hafer, chairman of the Department of Economics and Finance, and director of the Office of Economic Education and Business Research, at Southern Illinois University Edwardsville.

"Even with the possibility that the deficit projections are low-balling the future, market participants seem to have given the deficit little attention. Indeed, since 2000 the market has pushed the inflation-adjusted interest rate down, even as the projected budget shifted from large surpluses to large deficits. The conventional wisdom that the darkening deficit picture would cause the real interest rate to rise just isn't supported by the data.

"If surging deficits do not result in rising interest rates, should we ignore them? Of course not. But let's reiterate a couple of important points. First, the absolute size of the deficit is practically meaningless. The informative measure is the size of the deficit relative to the size of the economy. For example, even though the deficit for 2004 may be the largest in dollar terms, as a percentage of GDP it is smaller than those of the 1980s and early 1990s. Size may count in many things, but not here.

"Second, deficits reflect decisions by politicians. Those decisions alter the distribution of economic resources. This means that instead of debating the size of the deficit let's focus on the cause of the deficit. A deficit caused by tax cuts which put more money back into the pockets of wage earners has very different economic implications than a deficit caused by massive increases in federal spending programs. The problem is that we have both."

Hey Hey, Big Spender

And how much are Bush and his fellow Republicans spending? To hear the squeals of Teddy Kennedy and Tom Daschle you'd think they were slashing spending on wasteful and harmful social programs, but the opposite is true. The Journal last week noted the recent presidents' average annual real increases in domestic discretionary spending:

Lyndon Johnson, fiscal years 1965-69, 4.3 percent
Richard Nixon, 1970-75, 6.8 percent
Gerald Ford, 1976-77, 8.0 percent
Jimmy Carter, 1978-81, 2.0 percent
Ronald Reagan, 1982-89, 1.3 percent decrease
G.H.W. Bush, 1990-93, 4.0 percent
Bill Clinton, 1994-2001, 2.5 percent
George W. Bush, 2002-04, 8.2 percent

And the difference between the Demicans and Republocrats would be ... the donkeys are the party of fiscal restraint? No wonder Sen. John McCain keeps lashing out at the lawmakers swilling at the taxpayers' trough. Come back, Ronald Reagan.

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