Bruce Bartlett Washington-based author :
Of course deficits matter, but not all deficits are created equal. For example, there’s a big difference between a cyclical deficit, one that results automatically during a recession as tax revenues fall and spending on things like unemployment compensation rises, and a structural deficit, one that would exist even at full employment. Cyclical deficits are not only not harmful but are essential to economic recovery; only a fool would raise taxes or cut spending to reduce cyclical deficits. Structural deficits are much more serious and need to be minimized because they basically represent negative saving—eating the national seed corn—and reduce the long-run rate of growth and the standard of living by reducing investment or forcing us to borrow from abroad, which means that the returns to that saving accrue to foreigners in the future. There are other economic risks to structural deficits as well.
There is also a difference between deficits that are essentially exchanges of assets and those that involve the purchases of goods and services. The former are mostly benign, but neither are they stimulative when the economy is in recession. That is why the economy has not responded to the massive increase in the deficit in recent weeks—the federal government is merely exchanging Treasury securities for private securities. This may be a necessary part of fixing the problems in financial markets, but their economic effects are quite different than when a deficit is used to purchase goods and services. When that happens, total spending in the economy rises and thereby spurs short-run growth. This also explains why tax rebates are a very ineffective means of stimulating spending; theory and experience show that the money is mostly saved.
The stimulative effect of a deficit on growth even when used to purchase goods and services depends on whether there is unused capacity—unemployment, idle plant and equipment and so on. Of course, there can also be a long-run stimulus to growth if deficits are used to finance true public goods, such as infrastructure investments. Deficits that occur when capacity utilization is high raise inflation and interest rates, thus defeating their purpose. This gets us back to the problem of structural deficits.
The problem we have today is that we need short-run deficits that stimulate spending and we also need to sharply reduce the structural deficits that all budget experts know are coming shortly as the baby boom generation retires. According to both the CBO and GAO, federal spending as a share of GDP is projected to rise by about 10 percentage points over the next generation even if we never enact a single new spending program. Unless we either raise taxes or cut spending on politically sensitive entitlement programs by a significant amount, we will face future deficits that will be economically crippling.