Next Debt-Ceiling Histrionics Could Do Real HarmSimon Johnson
June 10 (Bloomberg) -- At this stage in the U.S. recovery, there isn’t much that fiscal policy can do to accelerate growth. Some argue that we need another tax cut, while others would prefer increased spending.
Neither is going to happen on a significant scale. Radical austerity is unlikely and tax reform remains elusive. New spending on worthy targets, such as decrepit infrastructure and early-childhood education, isn’t in the cards, either.
Nonetheless, significant decisions must be made: For one, there is a big gap between the budget proposals of the Senate and the House. These blueprints have major implications for some members of society. And the automatic spending reductions imposed under sequestration are proving, as expected, to be very blunt. No sensible country runs its government with across-the-board cuts.
The real worry, however, is that fiscal policy has the potential to derail the economy -- if the political debate becomes focused on whether to increase the federal debt ceiling later this year.
Most economists are deeply skeptical that the U.S. would ever default on its debt or even mess around with the priority in which creditors are paid. The consequences would be highly disruptive to the economy and greatly undermine the borrowing capacity not just of the government but of the private sector, too. Public finances at every level of government would be in disarray.
If the market for Treasury debt is damaged, no one in the private sector should expect to find it easier to borrow. Countries without credible sovereign borrowers don’t have strong private credit markets.
Unfortunately, it isn’t the opinion of experts that matters most, but rather how business people and consumers see the situation in Washington. In the summer of 2011, these observers witnessed a scary confrontation over the debt ceiling that greatly increased perceived uncertainty and undermined investment of all kinds. (See the work of Scott Baker, Nick Bloom and Steven Davis, which develops an index of economic policy uncertainty and shows a surge in anxiety during the previous debt-ceiling showdown.)
If leading politicians say the federal government should default, uncertainty will increase. And Congress could make it difficult for the Treasury Department to make all its obligated payments on time. Even 10 minutes of default would be a disaster.
We have lost our grip on what is appropriate and inappropriate in discussing fiscal-policy choices.
A shock that plunges the economy of any industrialized country into a recession will be met by automatic fiscal responses that seek to counteract the effect. These include spending increases (on unemployment benefits and other forms of social support) and tax cuts (as gross domestic product falls). In the U.S., where the central government is relatively small (compared with other industrialized countries), there are also important discretionary fiscal-policy choices that must be made in a deep recession.
For example, in 2008, the Heritage Foundation consistently argued for large tax cuts, specifically by making permanent those enacted under President George W. Bush (see these documents from January 2008 and October 2008). Under a Republican president and just before the presidential election, the conservative research organization’s advice was to use big tax cuts to boost the economy.
I also testified before several congressional committees, beginning in late 2008, and before that I served as chief economist of the International Monetary Fund. Regardless of party affiliation, the discussion in public and in private in late 2008 was about the appropriate form and scale of support for the economy: how much to cut taxes and how much to increase spending. There was no serious resistance to the notion that we were confronting the biggest crisis since World War II.
In industrialized countries, debt rose to 110.7 percent of GDP in 2012, from 77.2 percent in 2006 (this is general government gross debt as a percentage of GDP, calculated by the IMF as an unweighted average across countries; the data are from the IMF’s fiscal monitor). Most of this increase was caused by automatic stabilizers, as well as the higher spending (on programs such as unemployment benefits) and decrease in tax revenue that occur in a recession.
Seen in that context, the increase in the U.S. general government gross debt -- to 106.5 percent of GDP at the end of 2012, from 98.2 percent at the end of 2010 and 66.1 percent in 2006 -- was very much in line with the experiences of other countries. (Net debt, which excludes government debt held by other parts of the official sector, is a better measure but it is also harder to compare this across countries in a reliable manner.)
In terms of net general government debt held by the private sector, at the end of 2012, the U.S. was at about 89 percent of GDP, from 48.4 percent in 2007. This number will reach 87.6 percent in 2016 and 86.6 percent in 2018, according to the IMF (see the April 2013 Fiscal Monitor for the latest projections). Even so, this is unlikely to cause any kind of serious immediate fiscal crisis.
We must remain unhappy that we had a huge financial crisis. And we can complain that the form or scale of fiscal stimulus wasn’t to our liking (too small or too big).
We should have a reasonable discussion about the pace and method of deficit reduction now. I offered my views in testimony to the Senate Budget Committee last week. The hearing was cordial and productive. And we should also talk much more about what government should do and how we want to finance those activities in a sustainable manner.
The real danger is that the political process will produce another scary, needless confrontation over the debt ceiling that will significantly slow the recovery. The debt ceiling should be taken completely off the table.
(Simon Johnson, a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, is co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”)
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