The Deficit Commission Tsunami
November 08, 2010, 5:00am

Dean Baker.
Center for Economic and Policy Research.

During the mass unemployment of the Great Depression, Keynes once quipped that if we couldn’t find any productive work that needed to be done, in order to reduce unemployment we could just pay workers to dig holes and fill them up again. Keynes was being sarcastic, but it seems that the Washington crew picked up on this suggestion. This is the only plausible explanation for the proliferation of deficit commissions in our nation’s capital.

There are three separate deficit commissions prepared to share their wisdom with the American people before the end of the year. These three commissions all have two important features in common: Not one member these commissions warned of the catastrophe that would be created by the collapse of the housing bubble, and they all think it is a good idea to cut Social Security.
The country is currently experiencing its worst economic downturn in 70 years with more than 25 million people unemployed, underemployed, or having given up looking for work altogether. It might have been appropriate for a commission that purports to be giving advice on the future of the country’s most important social programs, as well as the overall budget, to include at least one person who was awake enough to notice the $8 trillion housing bubble that wrecked the economy.

But, these commissions want to tell the public what is best for us and don’t feel that they need to bother with trivialities like the economic collapse. In fact, the commissions include many of the people who had helped guide our economy off the cliff. They see their credentials in this capacity as lending to their credibility. This is sort of like an officer from the Titanic using this experience as a basis for being appointed ship’s captain.

In fact, these commissions don’t have much other than their credentials to support their recommendations for cutting Social Security and Medicare. While the media have been hyperventilating at length to try to build fears about the budget deficits it is easy to show that these fears are unwarranted.

In the short-term the United States has large budget deficits for the simple reason that private sector spending collapsed. The arithmetic is straightforward. The collapse of the bubbles in residential and non-residential estate led to a plunge in annual construction demand of more than $600 billion a year. The indirect effect of the loss of $6 trillion in housing bubble wealth was to reduce annual consumption by $600 billion a year.

With a total loss of $1.2 trillion in private sector demand the choice for the government is either to boost the economy by running large deficits or allow the economy to contract further and let the unemployment rate rise even higher. If our deficit hawk commission members knew their economics, they would have been warning of the housing bubble in 2002-2006. Then we could have avoided this economic collapse – and we would have had smaller deficits.

It is important to realize that the debt that we are incurring at present need pose zero burden on future generations. We are putting to use resources that would otherwise be idle, not pulling resources away from the private sector. While the deficit hawks eagerly threaten us with the prospect of our children paying interest on trillions of dollars of debt, the Federal Reserve Board could simply buy and hold this debt, leading to no net interest burden on future generations. (The Treasury pays interest on the debt to the Fed, which then refunds the interest payments to the Treasury at the end of the year, leaving no net interest burden.)

While the longer term projections do show a serious deficit problem even after the economy has recovered, this is due to projections of exploding health care costs. Since more than half of our health care is paid by the public sector, if health costs really do grow out of control, then it will lead to very serious budget problems. Of course, if health care costs follow the projected path then they will also devastate the private sector.

The point is that we have a health care problem. If we don’t fix our health care system then our economy will be in serious trouble, with one problem being large budget deficits. If we do fix our health care system, then there is no long-term deficit problem.

The basic story is that in the short-term there is no deficit problem; the problem is a plunge in private sector demand caused by the collapse of the housing bubble. In the longer term the deficit problem is actually the problem of a broken health care system. The facts are as clear as can be.

So, why then do we have all these deficit commissions? It’s simply modern Washington’s way of digging holes and filling them up again. It gives these people something to do. Let’s hope it ends up being harmless.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy. He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues.