Maybe big deficits are the solution, and not the problem

I originally posted this as a comment on On Deficit Proposals, a Failure of Will and Not Ideas on the New York Times Economix blog.  In that blog post it was argued that the deficit has never been controlled because of lack of political willpower to do the right thing.

Maybe the reason that the deficit has not yet been reduced is because reducing the deficit would be harmful to America. Maybe the invisible hand of the political marketplace is arriving at the correct solution (ever increasing deficits) and fending off attempts to undermine the economy via deficit reduction.  Maybe it is not a coincidence that the governments of all wealthy nations run large deficits. Maybe running a large deficit is a necessary element for sustained economic growth.

In order for the economy to not shrink total spending (consumption + investment) has to equal total income. In other words, every dollar earned must be spent one way or another. If less is spent than is earned in a period then in the next period someone is going to have less income because of that reduced spending.

As long as there are adequate profitable investment opportunities available (i.e. every additional dollar spent on real capital yields an acceptable profit) then any income that is saved instead of spent on consumption can be loaned (at interest) to entrepeneurs who will then spend it on capital investment and keep overall spending equal to income.

However, if the supply of savings exceeds the supply of profitable investment opportunities you will see (1) interest rates fall as the supply saved money exceeds the demand for investment spending, and (2) economic growth stagnate or go negative as total spending falls short of total income.

When the economy stagnates the government can rescue the situation by reducing the excess supply of saved income by (1) raising taxes and/or (2) borrowing more and then spending the proceeds.  This keeps the economy growing when it would otherwise stagnate or shrink because savings exceeds spending.  Although nobody talks about it in these terms, maybe the invisible hand of political economy has been making it happen for decades via the mechanism of the government borrowing more and spending more to avert "short term pain" whenever the economic growth starts to go soft.

Maybe exercising political will to reduce the deficit in the face of a stagnant economy would be the worst possible thing to do right now.

People with high income tend to save more of their income.  Policies that shift more of total income to high earners will tend to increase savings, which will in turn make it more likely that the economy will stagnate because savings exceeds profitable investment opportunities.