Why does this year’s deficit seem to create so much controversy? In theory large deficits threaten future prosperity. That’s because when governments run deficits they must borrow to make up the difference. The borrowing comes from scarce funds and can bid up interest rates. This can slow productivity growth—the cause of rising living standards.
Andrew Chamberlain blogg “Do Deficits Matter,” shows that this is not necessarily the case. “The historical relationship between deficits and interest rates is murky.” Many things in the economy affect the interest rates. It seems that government borrowing and interest rates tend to move in opposite directions altogether.
Deficits are clearly harmful to some extent. The question is to what extent? The average deficit, over the last 42 years, has been 2.1 percent of the GDP. In order for deficit to be considered large it must be 5.9 percent of the GDP or larger.
This year’s deficit is projected to be 3.6 percent of the national income. In the 1980s and 1990s the deficits was 4-5 percent and “hardly cause for panic.”