If you’ve been reading my work for any of the last 10 years you know that I’ve sounded like a broken record for much of that time – the USA isn’t bankrupt, interest rates aren’t going to rise significantly and inflation is contained.

All of this was based on an operational understanding of the monetary system within the context of a reserve currency issuing economy that was recovering from an unprecedented debt crisis resulting from an asset bust. One of the big conclusions from this view was that the government could (and should) expand its balance sheet to offset some of the private sector’s weakness. I argued that the policy response from the crisis focused too much on Fed policy and not enough on fiscal policy. I think it’s fair to say that these views turned out to be fairly right.

Fast forward to today. The USA is still not bankrupt. In fact, we are wealthier, in aggregate, than we’ve ever been. Interest rates are moving higher. And inflation, while still contained, is moving a bit higher. I am not terribly concerned about surging interest rates and inflation. But there is still reason for caution regarding the deficit. Let me explain.

Typically, the deficit moves in a relatively countercyclical fashion. It is largely automatic as, during recessions, tax receipts decline and non-discretionary spending rises and, during booms, tax receipts jump and non-discretionary spending falls. The deficit ebbs and flows and as the private sector strengthens during a recovery the need for government assistance declines and so the deficit naturally recedes. This is a good thing as we get some extra support when we fall and the support gets reduced as we strengthen and rise.

What’s happening now is rather unusual though – the deficit is surging in a highly procyclical fashion due primarily to discretionary changes in the tax code. So tax receipts are declining during a boom.