Blow up the deficit!
The case for a $1 trillion annual shortfall in the federal budget
As most working Americans could tell you, the economy is still not doing well.
Right now, political pressure to fix this tends to focus on the Federal Reserve. When the Fed hikes interest rates to curb inflation, it also risks squashing job growth. So activists like the Fed Up campaign are pushing Fed officials to lay off their recent interest rate increases. And a bevy of economists just released a letter urging the Fed to target inflation higher than 2 percent.
But the Fed isn't the only culprit here, or even the most important one. That would be Congress. One of the letter-signing economists, the Economic Policy Institute's Josh Bivens, told a press call that he'd be a lot less worried about the Fed's inflation target if Congress was actually doing its job with fiscal policy.
When people talk about the Fed versus Congress, they mean monetary policy versus fiscal policy, respectively. Putting it crudely, the central bank oversees the supply of money in the economy, increasing that supply by lowering interest rates, and decreasing it by hiking interest rates. Congress handles taxing and spending policy.
That's how America does it and how most countries do it, too. But you could easily imagine a government that didn't separate the two: It could just print money whenever it wanted to spend on a safety net program or an infrastructure project or whatever. That we even think of "running a deficit" or "going into debt" as something the federal government does is an artifact of the monetary-fiscal policy split.
The fear is that such a government would inevitably print too much money and drive the economy into hyperinflation. So the economic mainstream's justification for the monetary-fiscal policy split is that elected officials can't be trusted to govern the supply of money. Instead, the job goes to a group of technocrats — i.e. Fed officials — who are insulated from day-to-day political pressure.
But this argument hides an extraordinarily radical implication: Congress can run whatever fiscal policy it wants! Deficits to the sky, if it feels the urge! Whenever deficits threaten to drive up inflation, the central bank can just step in with higher interest rates and cool things off.
Of course, the economic mainstream would be horrified by that logic. Their rebuttal? That higher interest rates damage the economy. So Congress shouldn't tempt fate, and should balance its budget.
This is where things get perverse.
The trouble is, dumping more money into the economy does not necessarily lead to inflation. Where the money goes matters enormously: If it goes to the rich and just winds up circulating uselessly in the financial markets, it won't do squat. This is one of the basic problems with President Trump's proposed tax reform — it would blow up the deficit while handing the vast majority of its benefits to the wealthy. This also appears to be what went wrong with the Fed's quantitative easing program.
So when does new money lead to inflation, and thus to the need for higher interest rates? When it creates enough new jobs to max out the economy's capacity to employ people. At that point, if you keep dumping new money into the economy, it doesn't have anywhere to go except into price increases.
So how is that perverse? Well, think of it this way: The ultimate goal of economic policy is to provide good jobs and wages for everyone. But it's only when that goal has been achieved that deficit spending starts to pose a serious inflationary threat. So when people fear that deficits will lead to inflation, what they're actually scared of is a fully functioning and healthy job market. See what I mean?
Now I don't mean to undersell the dangers of inflation. Once you've maxed out the economy, cooling any further overheating with higher interest rates is indeed a good idea. Hiking rates is a only bad idea when the economy is already underperforming. (Like now.)
A healthy economy is a fine balance between the upward pressure of jobs for everybody, and the downward pressure of keeping inflation in check. It's the Fed's job to supply the downward pressure, but it's Congress' job to supply the upward pressure. And the Fed is in a far better position to do its job well when that upward pressure is constant and strong. Then the Fed can keep interest rates high to keep inflation low. Plus, if there's a recession it would have plenty of room to cut rates to give the economy a boost back to health.
Instead, Congress is austerity obsessed. So the Fed finds itself in a world where the upward pressure is incredibly weak, and its unable to coax the economy back to life on its own. Hence the call for a higher inflation target.
So what sort of deficit spending would do the job? The kind that gets the money to the poor and the working class instead.
A particularly big and simple way to do this would be to just scrap the payroll tax. It brings in roughly $1 trillion annually, and it falls especially hard on low-income workers. Eliminating the payroll tax would put a lot of money back into working Americans' pockets, and make it cheaper for businesses to hire people. Some people would object that we're defunding Social Security or Medicare, but remember: Their benefits are backstopped by the government's unique money-creating powers as much as any other program.
Other ideas include Rep. Ro Khanna's (D-Calif.) proposal for a $1 trillion increase in the earned income tax credit. Again, this would be a big boost to the wages of the poorest Americans, and thus to aggregate demand and job creation. He's proposed paying for it with a financial transaction tax, but we could just as easily not pay for it as well.
There are plenty of other radical ideas we could play with, too.
But the basic takeaway here is that the whole point of handing monetary policy to the Fed is to render Congress' deficit spending harmless. Embracing a $1 trillion annual shortfall in the federal budget might seem a wild hair idea. But this is no time to think small. And if you believe in the need for that separation between monetary and fiscal policy, it makes zero sense to fear-monger about deficits.