Deficits Do Matter: They Can Improve Government Quality

Abstract

Economists have long debated whether deficits matter. They do, but perhaps more for replacing voting markets that reward politically attractive redistribution with financial markets that can better support productivity. Tax-funding mechanisms evaluate proposals to spend public resources in light of distributional consequences, not against the standard of whether public actions broadly expand economic opportunities. To attract funding through deficit financing, on the other hand, public spending proposals must reasonably promise to strengthen society's repayment ability. Moreover, financial markets (not voting markets) transparently report on the credibility of such promises by continually evaluating the price at which government obligations are traded. Having to borrow, not balance budgets, can productively discipline governments by charging a high price for funds that would facilitate transfers while readily supporting public projects that strengthen economic performance.

Keywords: Balanced budgets, public spending, deficits, financial market discipline, economic performance

JEL Classification: D70, E62, G32, H11, H62