Meanwhile, Republican scientists who presumably spent the last eight years locked in a vault in the basement of Heritage run out into the metaphorical street screaming that they have just made a shocking, horrible, and totally unexpected new discovery: budget deficits will make the economy melt down into a pool of manufacturing-depleted sludge, and also, cause rabies.
First of all, I think Megan would like our basement. It has a smoking lounge and everything. More substantively though, let's move on to Megan's bottom line:
The problem with the budget deficit is that, unlike the deficits George Bush ran, the deficits projected under Obama (and beyond) are actually large enough to potentially precipitate a fiscal crisis. If our interest rates suddenly spiked up, perhaps because lenders were worried about the size of our budget deficits, we'd find ourselves in the kind of nasty fiscal jam that regularly plagues third-world countries.
Megan might be surprised to learn that this is exactly what our basement scientists have been saying both before and after Bush left office. On February 25, 2008 Heritage's JD Foster wrote:
At the end of 2007, the debt-to-GDP ratio stood at 36.8 percent. The latest OMB forecasts show budget deficits through 2013, but they are sufficiently small relative to the size of the economy that the debt-to-GDP ratio falls to 33.4 percent by 2013. Similarly, the CBO forecasts a 33.2 percent debt-to-GDP ratio in 2013. The average of the two forecasts for 2013 is 31.6 percent, or 4.3 percentage points below the 2007 level. The Laubach study suggests, therefore, that the expected progress on reducing the debt-to-GDP ratio over the next few years is putting downward pressure on long-term interest rates equivalent to 15 to 20 basis points. Together, the Engin and Hubbard study and the Laubach study suggest a tentative, developing consensus about the general magnitude of the effects of deficit financing on real interest rates. The studies appear to suggest that, for deficits and debt levels in the ranges seen in recent years and projected in the medium term, the effects on real interest rates are in the expected direction, consistent across episodes and across estimating methodologies, and very slight--measured in terms of a handful of basis points.
Now fast forward to January 30, 2009:
At the end of 2008, the ratio of federal debt to GDP was about 44.9 percent. Under the assumptions here about new issuance and using the CBO forecasts for nominal GDP, debt at the end of 2009 will be about 57.9 percent, an increase of 13 percentage points in just a single year. By the end of 2010, the debt-to-GDP ratio will have reached 67.9 percent for a two-year increase of 23 percentage points.…
Using just the consensus estimates, the projected increase in the debt-to-GDP ratio for 2009 alone will raise interest rates by between 0.39 and 0.65 percentage points. In today's terms, the average mortgage rate at the end of January was about 5.33 percent on a conforming loan mortgage. At the end of 2009, if nothing else occurs, this rate would be between 5.75 and 6 percent. Using the consensus estimates, by the end of 2010 interest rates will be up another 0.3 to 0.5 percentage points, for a total increase due to the government debt bubble of 0.7 and 1.1 percentage points. That would mean that today's mortgage rate of 5.33 percent would be between 6 percent and 6.4 percent. Such increases in interest rates would significantly weaken the economy further and delay for many months any hope of significant recovery.
In other words, debt-to-GDP ratio's in the 30s: no big deal. But debt-to-GDP ratio's in the 60s: big problem. As Jonah Goldberg has said, just because I drive 65 mph in a 55 mph zone doesn't mean I can't want to see a guy going 130 mph throw in jail.