To those in charge, this story of cause-and-effect seemed almost self-evident. But even then, there were reasons to question it.
For one thing, the cause-and-effect might have been backward. Maybe the economic boom caused the surpluses, not the other way around. And continuing fiscal surpluses meant a falling supply of Treasury bonds, the bedrock of the global financial system. Could that have been destabilizing?
Some economists thought so, for example, Stephanie Kelton, who as a young scholar studied under the groundbreaking Cambridge economist Wynne Godley. In their thinking, the American combination of government budget surpluses and current account deficits — meaning importing more than exporting — would cause private debt to rise. And private debt, they said, is more dangerous than the public kind; private borrowers cannot create money from thin air.
In 2001, the boom turned to recession. The Bush administration sought lower income tax rates, especially for investment income, and passed them in 2001 and 2003. In 2003, Congress and the administration created an expensive new Medicare prescription drug benefit. The country faced the new costs of wars in Afghanistan and Iraq. The surpluses vanished.
Interest rates and inflation remained low throughout the Bush years even as deficits soared, and rather than being crowded out by government borrowing, capital was freely available to private borrowers — so much so that it fueled a housing bubble.
Then came the global financial crisis.
The steep contraction in the economy in 2008 and the first half of 2009 caused tax revenues to plummet and social safety net spending to soar. The Obama administration advanced a deficit-financed $787 billion package of spending and tax cuts to contain the economic damage.
But strikingly, even amid soaring deficits, President Obama embraced the language of the old Clinton-era consensus. “It has never been more important to ensure that as our economy recovers, we do what it takes to bring this deficit down,” he said in his first address to Congress in early 2009.