During the Great Recession and its aftermath, leading economists across the political spectrum, from Paul Krugman
to Martin Feldstein
, argued that we needed a stronger fiscal response — larger deficits. In a recession, they pointed out, larger deficits boost aggregate demand and help the economy return to full employment. Several well-designed studies
about the 2009 stimulus package have corroborated this conclusion.
The situation today is quite different, though. The economy already is near full employment
, but deficits are running at 4.2% of GDP. By comparison, the last time
we had full employment, in fiscal year 2007, the deficit was only 1.1% of GDP.
And the fiscal outlook
only gets worse looking forward. Under plausible scenarios, the debt-to-GDP ratio will rise steadily to almost 200% over the next 30 years (up from 78% today), nearly double the previous peak
just after World War II. Worse, the rising debt is due to a chronic, built-in imbalance between spending and revenues, not the temporary effects of a war.
point out that low interest rates can, in certain circumstances, prevent the debt from rising relative to the economy, eliminating the need to raise taxes or cut spending. But while interest rates are indeed low, US primary (excluding interest) deficits are large and persistent. That means that rather than staying constant or falling over time, the debt-to-GDP ratio is projected to rise
inexorably in the future, even if the economy stays strong and even if interest rates remain low.
If policymakers do not address the fiscal imbalance during our current economic boom, it will only get harder to do so in the future. The problem will be bigger, the economic consequences will be more severe, and the political challenges of cutting spending and raising taxes will grow.
Although debt that finances government investment can boost the economy in the long term, federal investment in infrastructure and human capital is slated
to decline as a share of the economy. Instead, the debts we are projected to accumulate stem largely from an aging population and large, poorly targeted tax cuts. As a result, the sustained deficits will reduce future national income. Deficits tend to reduce national saving
— the sum of saving by the private and public sector. Once current national saving falls, future national income will also be dragged down. This could happen through higher interest rates, which choke off investment and reduce future production and income. Or it could happen through capital inflows, which allow us to maintain production but require the nation to repay its debts to foreign lenders.
Sustained deficits and rising long-term debt also make it more difficult to garner political support to conduct routine policy initiatives, address major new priorities, or deal with the next recession, war or emergency.
Addressing the long-term fiscal imbalance now does not require immediate, abrupt changes. Instead, we should phase in reforms to future spending and revenues. Social Security, where beneficiaries face mandatory 23% benefit cuts
in 15 years in the absence of new legislation, would be a good place to start. The longer we wait, the larger and more disruptive the eventual policy remedies will need to be.