How Ryan Went Wrong on Spending and Growth

(Originally published here.)

Near the end of his latest budget proposal, Representative Paul Ryan says that his $5.1 trillion in spending cuts will boost the economy so much that the federal budget deficit will shrink by $175 billion during the next 10 years.

But don’t blame Ryan for this prediction. It is based on a concept that springs from the nonpartisan Congressional Budget Office. It’s the technocrats at CBO, not ideologues, who think that government debt is bad for growth — in the absence of either solid evidence or persuasive theory. Small wonder Ryan’s passion for cutting the budget.

Although the CBO avoids measuring the impact of specific policy changes on growth, it has no trouble making sweeping claims about the consequences of federal government borrowing on the economy. Here’s a passage from a paper it wrote in response to Ryan’s latest budget:

Over time, lower federal debt leaves more funds available for private investment and thereby causes output to be higher than it would be otherwise. Higher federal debt has the opposite effect, “crowding out” private investment and decreasing output.

Here’s how it incorporates that thinking into Ryan’s budget proposals:

Economic output would be lower in the short term (because less federal spending would reduce total demand for goods and services), and higher in the long term (because less federal borrowing would free up resources for private investment), than under any of the other scenarios that CBO considered.

And it produced this graph:

Let’s forget for a moment that the last few times the U.S. boosted the rate of private investment we ended up with two of the most wasteful bubbles of all time. Instead, let’s focus on the CBO’s “crowding out” argument. If you believe this assertion, then an increase in the budget deficit should raise borrowing costs for businesses and a decrease would do the opposite. But we don’t see that when we compare the budget deficit as a share of gross domestic product to the inflation-adjusted interest rate on corporate-bond yields.


The budget deficit is still large yet interest rates are lower than they were in the late 1990s, when the government was running a significant surplus. Even if the relationship were stronger, there is no theoretical reason to believe that government borrowing raises the cost of private investment. In fact, economists now think that government borrowing lowers the cost of private investment byimproving the quality of collateral in the financial system.

Besides, changes in government borrowing can be almost entirely explained by the business cycle rather than specific policy choices. When the economy is weak, fewer people are working and spending, which reduces tax revenue and temporarily increases the burden on the safety net. As the economy recovers, the deficit shrinks.

Similarly, interest rates are also determined mostly by the business cycle. Initially, rates might rise as lenders try to offset losses on loans; once the economy is in real trouble, though, demand for credit falls and interest rates decline. And when the economy is booming, investors are less attracted to bonds than stocks, so interest rates tend to rise. Both investment and budget deficits are the effects of something else rather than determinants of changes in business spending.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter at @M_C_Klein.)

To contact the writer of this article: Matthew C. Klein at

To contact the editor responsible for this article: James Greiff at


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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