Should we pay off the national debt with part of the budget surplus, as President Clinton proposed? The conventional answer is "of course." Retiring the debt would increase the national savings rate and spare the government the expense of paying interest. But there is a reason why we should not: Without debt, the Federal Reserve would have a trickier time conducting monetary policy.
Ever since the Fed became a true central bank, its most important monetary lever has been "open market operations"--buying or selling Treasury securities to expand or contract the money supply. (The Fed also raises or lowers the discount rate, but it fine-tunes its monetary targets in the open market.) Obviously, once the national debt is retired, there are no more Treasury securities to buy or sell.
In principle, the Fed doesn't need Treasury securities for its open market operations. It could use a basket of state and municipal bonds, AAA corporates, and other federal instruments, like Freddie Mac bonds. But these are not backed by the full faith and credit of the United States. They are not nearly as safe. What would take the place of Treasuries as a benchmark? Would financial markets become more volatile? The answer is: No one really knows.
Economists on both the supply-side right and the Keynesian left have expressed alarm. For example, Bruce Bartlett of the National Center for Policy Analysis recently warned that without Treasuries, bond dealers would have a harder time pricing corporate and municipal bonds and that savers would be deprived of government savings bonds. James K. Galbraith of the University of Texas, who agrees with Bartlett on little else, observes in the same spirit that "we run the most liquid debt market in the world, which is why the dollar is the reserve currency and why flights to quality don't fly from us..." Moreover, Galbraith worries that if the Fed starts buying and selling private corporate and municipal securities, it would soon begin to affect their prices---something Alan Greenspan seemed so concerned about when he warned against a federal mutual fund for Social Security.
The way retiring the debt would affect monetary policy is an intriguing teaser and perhaps a potential problem. But the deeper issue is what this country should do with its new windfall--a 15-year government surplus now projected at nearly $6 trillion, more than a trillion dollars above earlier estimates. Paying off the debt, as Clinton proposes, precludes using most of the money for tax relief or for public spending. Bartlett is sounding the alarms about paying off the debt mainly because he would rather have a tax cut. Galbraith, in contrast, wants the government to use deficits some of the time for economic stimulus and to underwrite public purposes.
Clinton initially succeeded in blocking a national debate over what to do with the surplus by pledging that it would be locked away to shore up Social Security. When the surplus turned out to be enough to accomplish that goal and more, White House budgeters momentarily panicked and Republican tax-cutters broke out the champagne. But Clinton quickly stepped forward with an ill-defined "trust fund" for children's needs, Medicare drug benefits, and a plan to pay off the national debt. These initiatives had three things in common. They were thought up almost on the spot rather than being carefully considered as policy initiatives, they passed the test of quick public opinion polling, and they soaked up money Republicans wanted for tax cuts.
MEAGER WAGES. The country deserves a real debate over the surplus, and it isn't getting it. Should we cut taxes--and if so, how? Or should we restore government spending in areas that the public seems to want and the economy seems to need? The enlarged surplus reflects two factors--a higher-than-anticipated growth rate and the effect of the budget caps that are the enforcement mechanism of the 1997 Balanced Budget Act. Because of the caps, public spending will fall from 19.7% of the gross domestic product to 16.6% in 10 years, crowding out most spending other than social security, Medicare, and defense.
I have argued in this space that certain public outlays complement the New Economy--outlays for education and training and housing that will keep full employment from being inflationary. Many in both parties would rather return part of the windfall to the taxpayers or use it to supplement the meager wages of workers too poor to pay taxes, via an enlarged earned income tax credit. Paying off the debt introduces a wholly extraneous complication, which might also compromise monetary policy. Instead, let's have a real debate between tax cutting and public investment.