All Commentary
Wednesday, March 16, 2011

Government Borrowing Won’t Create Savings

Keynesian fantasies.

I long have believed there are two schools of thought on our current economic crisis and its effect on the federal government’s budget. The first is that the government must stop destroying the dollar, cut back all spending, and give up trying to “stimulate” the economy back to health.

On the other hand, some don’t care. The end is near, and there is no way to change the direction of things. So let’s have a toga party. Washington has too many interest groups wanting too many things, so we are supposed to pretend we are prosperous even if we are not.

The first view is more often heard, but the second seems to reflect how the political classes really act.

However, there is also a third viewpoint: There is no crisis at all. The U.S. government can borrow money indefinitely and by so doing, those debts magically will morph into “savings.”

I’m not joking. In a recent column, Paul Krugman (who wrote in his bestseller The Return of Depression Economics that when the government prints money, it can create a “free lunch”) said that in the short term the government is doing just fine and in the long term Obamacare will lower federal deficits

[Y]ou have to realize two things about the fiscal state of America. First, the nation is not, in fact, “broke.” The federal government is having no trouble raising money, and the price of that money — the interest rate on federal borrowing — is very low by historical standards. So there’s no need to scramble to slash spending now; we can and should be willing to spend now if it will produce savings in the long run. [Emphasis added.]

Second, while the government does have a long-run fiscal problem, that problem is overwhelmingly driven by rising health care costs….

So if you’re serious about deficits, you shouldn’t be pinching pennies now; you should be looking for ways to rein in health spending over the long term.

For Krugman, newly created or government-borrowed money seems to have a magic all its own. Just stir in new money and the economy magically blooms. However, as the Austrians and many in the neoclassical mainstream note, that is not an economy; it is a creation of some academic economists. A real economy involves heterogeneous assets and capital, with resources being moved via entrepreneurship from lower valued to higher valued uses.

The Scenario

The Krugman scenario seems to go as follows: 1) the government borrows and spends at its current record levels; 2) at some point the economy gains “traction” and then moves forward on its own; and 3) the budget deficits morph into surpluses and the savings Krugman refers. That might be true in Krugman’s highly stylized world in which academic economists create “models” that can be manipulated into affirming whatever their creators desire, but in the real world of heterogeneous assets and factors, that claim is nonsense.

What about Obamacare? Won’t it lower medical costs and thus drive down the costs of Medicare and Medicaid? One has to remember that Krugman is not referring to opportunity costs, as economists understand costs, but rather administrative numbers. In his view, just lower the numbers by fiat (which is done mostly by delaying or denying care), and the deficits take care of themselves.

Free marketers might lament that Krugman’s views receive top billing in Washington, but we should not be surprised when the words of a hardcore statist are welcomed by those who wield political power and benefit from it. In the end, the economic crisis is the ugly child of politics as usual, and now it is time to pay the piper.?

  • Dr. William Anderson is Professor of Economics at Frostburg State University. He holds a Ph.D in Economics from Auburn University. He is a member of the FEE Faculty Network.