The Rice Thresher (Houston, Tex.), Vol. 69, No. 22, Ed. 1 Friday, February 19, 1982 Page: 6 of 24
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FACULTY FORUM/by Alison Bober
The following is a condensation
of an interview with Professor
Gordon Smith, the Chairman of
the Economics Department.
A big item in the economic news
lately has been the growing deficit.
Despite Reagan's promises to
balance the budget, he now
predicts a deficit of $98.6 billion
for fiscal 1982. U'hat effects to the
I S economy result from such a
large deficit?
J just talked to Bob Barrow the
ether day about this; he's one of
the leading young macro-
economists around, and he has
revived a thread of thought from
the e<;rly nineteenth centry, called
the- R icardo Equivalence
Theorem. This basically states that
no matter how the government
finances the debt, in terms of its
real effects, it always has the same
consequences; in particular,
whether the government today
would finance its expenses by
issuing bonds or by raising taxes,-it
would make no difference in the
real economy. It should not affect
interest rates, it should not affect
savings and a right-thinking
person who believed this would be
indifferent between government
deficit finance and government
taxation.
Say government expenditures
remain the same, you might want
to worry about government
expenditures: maybe they're too
high, maybe you don't like what
they're doing. But that's a separate
issue from the deficit as such.
You've got these levels of
government expenditures, you've
got to get the resources to finance
them somehow. One way to get
them is to levy taxes on people so
that the current expenditures and
current resources used up are
taken out of current receipts by the
government. The other way is to
issue debt, i.e., have a deficit and
then sell government bonds, notes,
and bills in the capital market.
What do the Wall Street
economists say will happen as a
result of this? They're saying that
when the government tries to sell
more of these debt instruments
concomitantly with a tight money
policy, this is inevitably going to
raise interest rates to fairly high
levels. This happens as the
government attempts to squeeze
out these resources from the
capital market at the expense of
private borrowing.
Borrow's approach says "Hey,
wait a minute." maybe deficit
finance is much closer to taxes
than we would think at first.
Clearly, when we issue those bonds
out there, that is going to wrest
resources from the public just as
taxes do. What does that do then?
T he people who buy the bonds give
up current resources to the
government in exchange for an
asset — the bond. But who's going
to pay the return on that? Every
time someone gets a bond, there is
implicit in that operation the idea
that taxes will have to be paid in
order to pay the interest. So
somebody out there has tax
liabilities. Now, through some
fairly sophisticated economic
reasoning involving the
Overlapping Generations model or
the Pure Consumption Loan
model, you can get a situation
where every person at every point
in time has in essence equal
assests—government bonds —
which pay a return that will be
exactly offset by the future tax
liabilities that will be incurred in
order to service the thing. And
that's a very different way of
thinking about things than the
Wall Street way. Because if this
line of reasoning were correct, then
there would be nothing to worry
about the deficit, per se. What
you'd want to worry about is the
changing in these things, the
lack of stability, perhaps, in tax
rates.
But eventually the bond has to be
paid for.
Obviously bonds do come due,
bills do come due—whoever's
holding it gets paid off by the
government. But of course the
government pays for it by issuing
another note. So they're
continually rolling over their debt.
The only way that the government
is going to buy back net bonds or
bills or notes from the public is to
run a surplus. That is to say, take in
more tax money than they spend,
using the difference to retire the
debt. That would be the surplus
problem. Back in the 60's when the
Kennedy tax cut was proposed, the
worry was government surpluses;
that was the vilain that would be a
drain on the economy by
depressing consumer and
investment demand. The
government would supposedly
cause a recession by taking away
too many resources and not
spending them. Now it's the
government's deficits we're
worrying about.
Whether or not Barrow's
hypothesis is right, if Wall Street
doesn't believe that it is—Then it's
not right. It can't be.
How is Wall Street reacting?
because that up and down carries
economic waste with it. It follows
that during recessionary times, the
optimal policy would be to rely
more on deficit finance as the tax
revenues flow back because of the
recession, and then rely on
surpluses when the economy is in
good shape. So Barrow argues that
far from being this glum, terrible
problem, the government debt is
merely maintaining its real value,
you can see that easily by looking
at the tables on national debt as a
proportion of GNP.
But it's certainly the case, that
when Wall Street doesn't believe
that world operates that way, then
Wall Street isn't going to behave as
if it did. But that doesn't make
Wall Street right. It's very easy to
show consistent periods of time
when Wall Street has been dead
wrong about what's going on in the
Gordon Smith
Apparently by believing
something quite different. And if
they do act that way, obviously
Barrow can't be right in terms of
what actually happens—which is
unfortunate, because he maintains
that the federal deficit now is
exactly as you'd expect it to be if
the government were optimally
financing its expenditures. Given
the rate of inflation as it is, all the
government deficit is doing now is
maintaining the real value of the
national debt. And he argues that
it is costly when you have
fluctations in the economy, it is
costly to keep changing taxes,
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economy, what the consequences
of economic policy are, and so
forth. There is a lot of evidence
that Wall Street makes big
persistent mistakes... Alas.
Wall Street is also in favor of
curbing the defense budget. If the
economy is moving again in the
way redicted by the tax cuts, to put
on top of that its splurge in military
equipment expenditures could
potentially be very dangerous, in
terms of a resurgence of inflation.
So you might say maybe that's the
kind of thing that Wall Street is
worrying about, especially for the
longer term. And it probably is.
Some critics have charged
Reagan with devising the new
Federalism to draw attention away
from the growing deficit. Is there
anything in the President's
economic program wheh indicates
that he will eventually get the
budget balanced?
No. In fact, I don't think there
ever was. Reagan is a Republican.
During his career he's beep a fiscal
sanity type of guy, balanced,
budgets and all that. It was not
clear that he was going to swallow
the Kemp-Roth-Laffer tax cut
plan, but he finally did. And when
he did that, it was clear that
balanced budgets were not a goal.
Only by the most wishful thinking
would one have a tax cut that large
and expect to balance the budget
by 1984. The supply-side people
were basically, when it came right
down to it, Keynesians in disguise.
When they took over, the chance
of a balanced budget became very,
very slight. I think that the most
hilarious thing of all, however, is
the Democrats running around,
falling all over themselves to
increase taxes and reduce
expenditues to balance the budget.
The players are all confused today.
We've got the Reublican defending
an enormous deficit, and we've got
the Democrats calling for fiscal
responsiblity. And the Democratic
party certainly has no record of
fiscal responsibility in Congress
for the last 20 years. It doesn't
bother me a bit that the budget
isn't balanced by 1984.
Balancing the budget has
become a war cry of Congressmen
and state legislators alike. Some
28-plus of the required 34 slates
have now requested that Congress
call a Constitutional convention to
propose a budget balancing
amendment. Would such an iron-
clad requirement be feasible?
I would be very skeptical that it
would actually pass, once people
realized what was actually
involved. Okay, we have a
Constitutional Amendment that
says the budget has to be balanced
over X period of years, say over
five years. Let's suppose that those
five years correspond to four year
of slack economic activity, which
tends to depress tax revenue and,
unless programs are cut, will tend
to raise expenditures because of
unemployment benefits. Four
years of slack in which a perfectly
normal balanced budget will turn
out to be unbalanced. What are
you going to do? Does it really
make sense in a perid of slack to
increase taxes and cut government
expenditures just because
somebody passed this damned
amendment that doesn't take any
account at all of the particular
situation you happen to find
yourself in? Sure, as an overall
goal, it makes some sense—maybe.
As applied to any particular
period, it can be very defeating. It's
not at all obvious that countries
that have large national debts are
countries that are going down the
economic drain. In fact, during the
1970's, the one economy in the
industrial countries that has stood
out in performance has been
Japan. And Japan has enormous
deficits.
APRIL 17
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Grob, Jay. The Rice Thresher (Houston, Tex.), Vol. 69, No. 22, Ed. 1 Friday, February 19, 1982, newspaper, February 19, 1982; Houston, Texas. (https://texashistory.unt.edu/ark:/67531/metapth245494/m1/6/: accessed July 18, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu.; crediting Rice University Woodson Research Center.