James Hamilton has an excellent discussion of why we should be concerned about the large current account deficits, while David Altig follows-up with the hope that this borrowing is only temporary. The point being made by James would have equally applied to the large deficits that followed the Reagan fiscal stimulus a generation ago as they apply today. During the early 1980’s, apologists for the fiscal stimulus tried to argue that borrowing to finance increases in investment could increase real GDP growth, but the facts were then that investment demand fell but not as much as to the decline in national savings. James provides a very nice chart showing net investment as a share of GDP from 1965 to 2004 as well as national savings. Despite the recent recovery of investment, its share of GDP is still quite modest, while the national savings rate is very low.
David, however, argues that low interest rates are not indicative of a “consumption binge”. While he notes the global savings glut hypothesis, his discussion is consistent with the driving factor being a decline in investment demand. In a way, David is hinting at the old Keynesian paradox of thrift justification for short-term fiscal stimulus. Sensible Keynesians, such as Robert Rubin, might continue by saying short-term stimulus might be good policy during a transitional investment slump, but the Bush call for long-term fiscal stimulus is not a pro-growth agenda. Simply put – as this transitional slump in investment demand reverses itself, the Federal Reserve will be compelled to raise interest rates if the fiscal stimulus is not reversed. Over the long-term, the extra consumption does crowd-out both investment and net exports.