(Bloomberg Opinion) -- For the past 40 years, the U.S. has had one fiscally responsible party and one fiscally irresponsible party. What happens when this changes?
Basic Keynesian economics says that deficit spending gives the economy a temporary boost. Faster growth means more jobs, which means people are happier. That probably leads to better electoral performance for the ruling party. So if Keynesianism is correct -- and the evidence mostly suggests that it is -- then every ruling party has an incentive to run big deficits.
The problem is that at some point those deficits could have negative consequences. If the public ever decides that the government has absolutely no fiscal restraint, spiraling inflation will eventually take hold. No one knows exactly how big deficits and debt have to get before that happens, so fiscal responsibility is typically a guessing game. But some amount of fiscal responsibility is necessary in the long run, assuming you don’t want to become Argentina. Traditionally, Keynesians have suggested that countries run deficits in recessions and wait until boom times to cut spending.
But that might be hard in a two-party democracy, where political strategy is also a factor. Because deficits boost the economy in the short term, it makes political sense to borrow and spend for the party in power, and to push restraint when the opposition is in power, no matter how the economy is doing at the time.
This appears to be the Republican strategy. Presidents Ronald Reagan, George W. Bush and Donald Trump all ran big deficits during economic expansions during the late 1980s, the mid 2000s and the late 2010s:
Meanwhile, the Republicans went to great lengths to demand austerity during and just after the Great Recession, precisely the time when belt-tightening would be most harmful. President Barack Obama ran up deficits in order to fight an enormous economic crash -- just as Keynesians would prescribe -- but the Tea Party forced an early end to the stimulus. Tea Party enthusiasm for austerity under Obama stands in sharp contrast to the words of former Vice President Dick Cheney, who is reported to have declared in 2002 that “Reagan proved deficits don’t matter.”
Democrats, however, have been content to be the party of fiscal responsibility. Bill Clinton was elected in 1992 on a platform of deficit reduction, and fulfilled that pledge by being the first president to balance the budget since Richard Nixon. Obama, although he ran deficits during the recession, seemed to have generally fiscally conservative instincts.
The U.S. therefore seems to have settled into a comfortable political cycle. Republican presidents run up deficits during good times and bad, while Democrats only increase borrowing when recessions hit. The only time deficits go down is when a Democrat happens to be president during an expansion.
But it’s possible that by agreeing to be the party of fiscal responsibility, Dems are shooting themselves in the foot. Maybe if Clinton hadn’t run surpluses in the late 1990s, the economy might have been a little stronger in 2000 and Al Gore might have won a close election. Similarly, if Obama had pushed harder for continued deficits over Tea Party objections, the mini-recession of 2016 might have been avoided and Trump would have lost.
Some voices on the left are suggesting that Democrats should emulate the post-1980 Republicans, and increase deficits any time their own president is in power:
Meanwhile, inflation hasn't emerged and interest rates have failed to rise in response to steadily mounting debt. That has made even sober-minded economists grow friendlier to the idea of deficit spending in general. In other words, the economic risk of Democrats abandoning fiscal responsibility seems to have diminished.
What would be the result if the U.S. went from having only one fiscally responsible party to having none? The Democrats could gain an electoral advantage in the next few election cycles. But it’s possible that the negative consequences of excessive debt -- a loss of investor and consumer confidence, leading to high interest rates and inflation -- could materialize earlier than expected. It might be that interest rates and inflation have yet to respond to rising debt precisely because markets expect Democrats to come in and clean up the mess. Take away that reassurance and markets might get spooked, making debt less sustainable.
The solution, of course, is for both parties to agree to tie deficit spending to the state of the economy rather than to political opportunism -- to allow deficits to increase when times are bad and to cut back when the danger ends, just as Keynesians would advise. But bitter partisan polarization may make such a pact impossible. Given Republican insistence on electoral advantage above all else, Democrats may have no choice but to respond in kind. The question of just how much debt the U.S. can safely sustain may soon get a definitive answer.
To contact the author of this story: Noah Smith at email@example.com
To contact the editor responsible for this story: James Greiff at firstname.lastname@example.org
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
For more articles like this, please visit us at bloomberg.com/opinion
©2019 Bloomberg L.P.