Deficits Don't Matter?

What is the nature of the danger? The only possible answer is that this larger deficit would cause a rise in the interest rate. Well, if the markets thought that was a serious risk, the rate on 20-year treasury bonds wouldn't be 4 percent and change now. If the markets thought that the interest rate would be forced up by funding difficulties 10 year from now, it would show up in the 20-year rate. That rate has actually been coming down in the wake of the European crisis.

So there are two possibilities here. One is the theory is wrong. The other is that the market isn't rational. And if the market isn't rational, there's no point in designing policy to accommodate the markets because you can't accommodate an irrational entity.

Well thank god that's out of the way, then! In fact, Galbraith says, deficits do matter, but only because, in his opinion, deficits are necessary for the government to function at all. It's true, as he says, "the government needs to run a deficit, it's the only way to inject financial resources into the economy. If you're not running a deficit, it's draining the pockets of the private sector."

Galbraith's remarkable frankness is his undoing, as he really needs to actually bolster his argument. The blog Super-Economy remarks,

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of course 20 years ago the markets did not expect Greece to default either! When the markets predict the future they assign low probabilities to unlikely events. Sometimes unlikely things happen anyway. This is absolutely not an evidence that the market is irrational.

...

It is a myth that having printing presses means you can never go bankrupt. At some point, quite soon actually, the inflation will be so high people will stop using your currency. That happened in Zimbabwe.

Expected U.S default and the ensuing global meltdown would come as soon as the investors realized the U.S intended to inflate yourself out of the value of the debt. People with money at risk know the difference between real and nominal dollars.

Thank goodness we have smart people on our side of the blogosphere who can very easily rebut arguments by left-wing supposed "intellectual giants" like Galbraith.