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Don't Panic Over the New Deficit Numbers

So what should we make of today’s other economic announcement--that the 10-year deficit projection has climbed to $9 trillion from just over $7 trillion earlier this year? Short answer: Not too much.

As the OMB fact-sheet accompanying the release points out, the reason for the bulk of the $2 trillion increase is that the recession was deeper than expected, which led to far greater spending on “automatic stabilizers” like unemployment insurance and lower tax bills. And, of course, bigger short-term deficits require more debt, which creates higher interest payments that further drive up the long-term deficit.

I don’t see huge substantive implications here. The biggest concern would be that foreign creditors--especially the Chinese--might clam up and slow their purchases of U.S. Treasury bonds, fearing that the deficit has become unsustainable. That could raise interest rates and sabotage the recovery. But Chinese Treasury-buying has stayed pretty strong all year, even after it became clear that the 10-year budget shortfall would be larger than OMB’s initial $7.1 trillion projection. (The Congressional Budget Office released an estimate of just over $9 trillion back in June.)

I’m actually wrapping up a piece on the U.S.-China economic relationship this week, and several Treasury officials have told me that, during the recent Strategic and Economic Dialogue, the Chinese confided that they would have been more concerned about the deficit had we not responded aggressively to the recession, even though the response made the short-term deficit larger. The Chinese understood the importance of running a big short-term deficit to offset our economic shocks and restore growth, these officials say. And the Chinese were apparently reassured when administration economic officials explained how much of the short-term deficit was a function of the recession and the financial crisis (about two-thirds). Not surprisingly, the Chinese are most concerned about the structural deficit (that is, the portion of the deficit left over once you strip out the effects of the economic downturn) and what happens to it over the long-term. Despite the ugly top-line numbers, that hasn't really changed--there isn't much reason to be more pessimistic about the long-term structural deficit than we were beforehand.

Politically, there will obviously be some attempt to incorporate the new numbers into the case against Obama’s domestic agenda. As OMB director Peter Orszag told the Times’ Edmund Andrews this morning, “A lot of people will look at this deficit and say we cannot afford health care reform.” (I suspect that’s the reason for making the Bernanke announcement the morning OMB released the deficit update.)

But I’d caution against over-emphasizing the implications of the new deficit numbers for health care reform. For one thing, from the perspective of creditors like the Chinese, health care reform at least gives you a chance at reining in long-term, structural deficits. (The savings may be speculative and far off in the future, but the alternative is the certainty of zero savings, which isn’t appealing given that health care costs drive so much of the long-term deficit.)

Meanwhile, domestically, the administration’s biggest problem on health care isn’t that it costs too much, but too little. That is, the administration’s insistence that health care reform has to be deficit neutral over 10 years, along with its preference that much of the financing come from within the health care system, has allowed critics to scare seniors with talk of rationing and death panels--the argument being that the savings used to pay for health care reform are going to come from Medicare recipients, etc., etc.

Now obviously the administration wouldn’t have adopted that constraint if it hadn’t been worried about taking flak on the deficit. But the effect of the deficit here is really second-order: The deficit constrained the administration's thinking about health care in ways that subsequently made its plan vulnerable to other criticisms; the direct effect on the prospects for health care reform--i.e., people flatly insisting we can’t afford it--hasn’t been nearly as damaging. I'd guess that will more or less continue to be true despite the new numbers.