Deficit matters...

Nota: beware the wrath of Brad DeLong, especially on all topics deficit:

In the absence of the 1990 and 1993 deficit-reduction packages, we would have had an extra 35% of GDP worth of government debt--an amount that using Greg Mankiw's and Doug Elmendorf's rules-of-thumb (which I regard as too optimistic) would have reduced year-2000 GDP by 2.5% via the effects of crowding out on income from private capital alone. That's a good third of the cumulative year-2000 surprise good luck boost to production brought about by the late 1990s boom: remove good policy, and the boom loses a third of its boominess. Remove a third of the boom's boominess, and you remove one of the three percentage points' worth of extra deficit reduction coming from the strength of the boom. (And I would argue that there are bigger linkages between the budget and the boom than Mankiw-Elmendorf allow.) [ .... ]

An America without the 1990 and 1993 deficit-reduction packages would have been an America in 2000 where the federal debt held by the public would have been 70% rather than 35% of GDP, and would have been rising at 5% points per year. I cannot imagine why Samuelson wants to argue that such an America would have been able to borrow abroad on a large scale to fund domestic investment rather than an America from whose unsustainable fiscal policies foreign investors would have fled in terror. I cannot imagine where Samuelson thinks the purchasing power to maintain domestic investment would have come from in the face of the switch of an additional $3.5 trillion of investors' portfolios into government bonds. I cannot imagine who Samuelson thinks he is fooling in implicitly claiming that such swings in the federal debt would not have had powerful impacts on investment in the short and medium run, and on the pace of economic growth in the medium and the long run. You cannot divert 35% of a year's GDP from financing private investment to buying government debt and expect it to have "tiny, or nonexistent" effects on the real economy.

I'll consider myself cowed and convinced! This seems about right. It's one thing to say that 1990 and 1993 reduction plans caused the boom--which would be akin to saying that deficit reduction in 2004 could spur yet another boom. Like Galbraith says, there's good reason to doubt that. But... colossal public debt certainly hampers growth, as DeLong says, not least by diverting trillions in domestic investment. Already this quarter, investment growth sagged to 7.2%, and it's a reasonable bet that we can pin some of the blame on mounting government debt.