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In the Nation's Interest

Learning the Wrong Lesson

U.S. fiscal policy has been so far off the rails for so long that too many people have lost their bearings. A case in point is a New Year’s column by Ross Douthat of the New York Times, in which he confesses a self-perceived sin in recent years of supporting deficit reduction. Before others go astray and fall into the same trap, we should map out this territory.

Douthat makes two separate but related mistakes. First, he jumps to a premature conclusion on the effects of a long-term policy experiment. And second, he conflates that long-term policy choice with a related but separate short-term choice.

Over the last decade, the nation’s debt burden – the ratio of the public debt to the GDP – has more than doubled, from about 35 percent at year-end 2007 to about 78 percent as of 2017. Douthat observes that the nation hasn’t fallen over “a looming ‘fiscal precipice,’” while output and wage growth have been disappointingly slow. He therefore concludes that all of the concern about the budget – both his own and others’ – was misplaced. Instead, Douthat says that “The best time to make deficit reduction a priority is when the inflation rate and the bond market give you some indication that you are headed for a dangerous inflationary spiral.”

Whoa, Nelly. Let’s review what it is that we worry about when we contemplate fiscal irresponsibility and excess budget deficits. We will see that the laws of physics are a bit more insistent than this column’s perspective suggests.

Fiscal irresponsibility entails two downsides – one slow-moving but inexorable, the other off in the hazy future but potentially sudden (if and when it occurs) and cataclysmic.

The former, a slow but progressive deterioration of our economy’s vigor, occurs because oversized deficits and rising costs of servicing the resulting accumulating debt drain the nation’s pool of savings and thereby crowd out business investment. Interest rates rise, and we rely even more on the less-predictable flow of borrowing from overseas investors. With interest rates higher, investment will be lower, and economic output growth, productivity growth, and wage growth will be slower. It is like a hardening of the arteries of the economy – not good for economic strength.

That is the inevitable and inexorable result of fiscal responsibility. It does not announce itself by slapping you in the face. But it always there, aggravating the problem of slow wage growth about which Douthat worries in his column.

Douthat expresses relief that the economy has not yet fallen over a deficit “precipice.” But switching back to the health metaphor, declaring deficits to be benign today is like consuming a high-fat diet for one week and then concluding that heart attack is a fairy tale. Make no mistake, Douthat’s precipice is out there, just as is heart attack for a committed sedentary overeater.

To be sure, the U.S. government can continue its fiscal misbehavior for as long as the credit markets are willing to play the enabler by lending at comparatively low interest rates. The United States is still the world’s largest economy, and we do continue to print the world’s reserve currency. In terms of financial standing, we remain “the best-looking horse in the glue factory,” given today’s elevated public debt levels virtually all around the world. A run on the full faith and credit of the world’s leading economy has not happened in modern times. There is no historical scenario to use for war gaming.

Still, is there some U.S. public debt level that would shock the world’s financial markets into panic? Surely. And given the current projections of exponential growth for the U.S. debt burden, how can financial market players possibly rule out a U.S. public debt explosion?

But let’s give Douthat all benefit of the doubt. Suppose that the credit markets would give infinite forbearance to an infinitely irresponsible federal government. Would any rational and responsible U.S. policymaker be willing to accept an ever-climbing debt burden, with ever-climbing debt-service costs strangling private business investment and innovation? Even with an iron-clad guarantee against heart attack, would we choose iron-clad, inelastic arteries and a continuing enfeeblement of our economy and prosperity growth? I think not. This is borrowing from future generations to finance our own consumption today. It simply is not fair.

And prudence requires that our elected policymakers not wait for a burst of inflation and a brewing financial-market revolt, as Douthat intimates, to start thinking about a sustainable budget plan. Like sharp chest pains and intense shortness of breath, the brink of a credit-market panic would be far too late.

To be perhaps excessively charitable to Douthat, he makes an arguable retrospective case for a larger fiscal response to the economic downturn following the financial crisis. Some economists and business leaders would agree, with the benefit of 20-20 hindsight. Others would not, and many would question how the stimulus was designed and would question merely enacting more of the same. But again, giving all of the benefit of the doubt, a larger one-time fiscal stimulus in no way would have precluded a prospective, gradual plan for long-term fiscal sustainability. Keep in mind that the fiscal tightening of the early 1990s set the stage for the longest and strongest business-investment and economic-output expansion – surely at least in part because of the predictability and confidence that sustainable fiscal policy instilled.

Kudos to Ross Douthat for his refreshing willingness to engage in self-examination. But better that he learn the right lesson. An ever-growing debt burden cannot lead to a good outcome. Devoting more and more of our collective income to servicing a largely foreign-owned public debt will stunt our prosperity, one way or the other. If the Congress and the President would enact sound, sustainable and bipartisan budget policy today – a New Year’s wish, to be sure – the Federal Reserve could respond accordingly, and our private business sector would have a more predictable economic and financial environment (with lower-than-otherwise interest rates) and all Americans – today and tomorrow – would benefit.