Super Nanny

At a well-attended conference on September 30, organized by the Center for American Progress and the Center on Budget and Policy Priorities, various experts discussed the federal budgetary outlook and its consequences.  They fell into two camps.  One group worries that the prospect of big, long run deficits will eventually spook bond markets.  They want the Obama administration to announce what it plans to do in the long run to raise revenues and lower federal spending.  The other group thinks that the budget needs less remediation, and that it is unnecessary to take the politically risky step of announcing future tax hikes and spending cuts.  Both paths – pre-announcing and postponing budget fixes –  carry risks.  Did anyone say the president’s job would be easy?

The federal budget deficit this year and next will run upwards of 10 percent of GDP.  That is a big number, bigger than any peacetime deficit in your lifetime, no matter how old you are.  Yet very few economists are worried about the deficits in these very bad economic times.  In ten years, the best forecasts expect a deficit on the order of 4-6 percent of GDP .  Very few economists are not worried about that prospect.   Today, the federal government has the responsibility to help bring this deep economic decline to an end.  But in the longer run, the federal government has the responsibility to keep the national debt and therefore the federal budget under control.  After the economy recovers, the debt cannot continue to grow faster than the economy, driving up the debt/GDP ratio every year.  

We need to worry about the debt/GDP ratio because, as it grows, our annual spending on debt service will grow too, as a share of the GDP.  Future taxation or future borrowing will have to grow to cover this debt service.   If our debt /GDP ratio grows without limit, eventually lenders will start to doubt our ability to service the future debt.  Doubts quickly can turn to panic in financial markets, and eventually rising debt/GDP will lead to financial chaos or a currency crisis.

Some experts evaluate the possibility of such a collapse in confidence in Treasury debt as a very remote risk, now and for many years.  Other experts say that no financial crisis ever is properly anticipated by the majority (or else it would happen sooner).  So one of these days, we will find ourselves ambushed by a stampede of bondholders, fleeing dollar denominated debt.  If that happens, we will have another deep recession.

The experts who think the debt/GDP ratio can continue to rise for a long time without worry, agree that we should discuss measures to fix our federal budget…but only sometime in the future after we are out of the economic mess we find ourselves in today.   Many of these experts worry that it would be political suicide to announce the intention to cut spending and raise taxes in the future.  They point to the political damage to the first president Bush, who agreed to tax increases, and the political success of presidents Reagan and, especially, the second president Bush, who cut taxes, raised spending, and never suffered any political consequences.

Since 1980, Democrats have been the super nannies of budgetary politics, telling the over-indulgent Republicans that they must bring some discipline into their fiscal management.  We cannot simply cut taxes, fight wars, and buy military toys, while keeping our basic safety nets in place, without damaging our bottom line.  Republicans, in the mean time have run up the national debt faster than GDP every year since 1980 in which they have held the presidency.   The structural long-run deficits created under the last administration, which president Obama inherited, are the reason the deficits will not go away after the economy recovers.

How long will bond markets tolerate undisciplined fiscal policy?  How much will voters resent an administration that tries to talk sense and apply rules of arithmetic to our budget?  Did I mention, this might not be easy?