The impact of the deficits

The impact of the deficits on savings and future income

William Gale of the Brookings Institution testified before the House committee on the budget today (testimony here: "Perspectives on Long-Term Budget Deficits"). Here's the part about the deficits, savings, and future income:

"Fourth, the economic effects of persistent budget deficits are gradual but they are debilitating nonetheless. The real problem created by budget deficits is that they reduce national saving, which in turn reduces the assets owned by Americans and hence reduces future national income. These effects can be sizable, especially in the long-term. Conventional estimates, based on models developed by the CEA Chair Gregory Mankiw, indicate that the decline in the fiscal outlook since January 2001 has reduced GDP by at least 1 percent in 2012 and national income per household by $2,300 in 2012. These effects will persist over time. To put it differently, controlling the deficit is a pro-growth policy.

Much of the public debate focuses on how deficits affect interest rates. The impact on interest rates can be an important channel through which deficits matter. But the debate about interest rates is--or should be--considered a sideshow. Persistent deficits reduce national saving and therefore hurt the economy even if they do not affect interest rates. regardless of whether interest rates rise. Nor does it matter if the deficit is completely financed by capital inflows. For example, even if capital flows in to offset the deficit, that only implies that domestic production does not fall. But since Americans would own fewer claims on that production, since they borrowed from abroad, their income would still fall."