Over the short term we want deficits...

Stimulus work(ed), deficit spending necessary over short term, long term revenue problems call for budget restraint write John Podesta and Michael Ettlinger in the Financial Times: 

In the face of a nose-diving stock market, frozen credit flows, rising unemployment and rapidly contracting growth in gross domestic product, Mr Obama and progressives in Congress passed the most aggressive stimulus package in history – the $787bn American Recovery and Reinvestment Act – after only a few weeks in office. It is no coincidence that, 10 months on, political debate centres around ways to hasten a recovery already under way rather than measures to contend with an economic collapse all too plausible a short time ago. GDP growth has risen from -6.1 per cent in the first quarter of 2009 to 2.2 per cent in the third quarter. Job losses, which peaked at 700,000 in January 2009, slowed to just 11,000 in November.

Now that the worst appears to have passed, many in Washington are focusing on the federal budget’s red ink. In fiscal year 2009 deficits leapt to about 10 per cent of GDP, a high not seen since the second world war. Some are calling for immediate fiscal restraint, ignoring the fact that a sudden drop in economic demand driven by dramatic cuts in the fiscal stimulus would derail recovery and hinder job creation in a still fragile economy. Others are invoking deficits to oppose reforms critical to rebuilding a strong economy – most recently the Senate’s healthcare bill, which would reduce deficits by $132bn in the first 10 years and by between a quarter and a half of a per cent of GDP over the next 10.

Today’s deficits are necessary and appropriate; they accelerate recovery. The deadlier threat lies in the long-term debt outlook. The deficit is projected to drop in the next few years, but never below 4 per cent of GDP; in 2014, the shortfall is expected to be at least $700bn. After hitting a low in the middle of the decade, it will rise for the rest of the decade and beyond. The mere anticipation of such a large, sustained deficit poses risks to financial markets and the economy, and undermines US standing. Markets, and the world, will worry about buying our debt, question investments in the US, and act with caution in fear of higher interest rates. When those deficits come to fruition, public expenditure will be siphoned from necessary services and investment into the abyss of rising interest payments on a growing debt. The debt might also leave the US unable to borrow further in the case of another crisis.

The scale of the deficit problem, and the risks it confers to sustainable economic growth, warrants the creation of a long-term plan to solve it. This means devising a path back to a balanced budget. Given the time necessary for the economy to reach full strength, and the uncertainties regarding war costs and the impact of health reform, our goal should be a budget in balance by 2020.

Such a distant goal will not be credible, however, unless today’s policymakers set intermediate targets. One should be to achieve primary fiscal balance – when government spending on current programmes equals revenues – by 2014. Overall there would still be a deficit, because we would still be paying interest on past debt, but it would be a huge step forward.

This target is simple, clear and easy to measure. Reaching primary balance would also mean US debt would cease to rise as a share of the economy – a critical milestone in returning to full health. The national debt climbed steadily under President George W. Bush; publicly held debt grew from $3,300bn in 2001 to almost $5,500bn in August 2008 as a result of tax cuts, the wars in Iraq and Afghanistan, and other unpaid for policy initiatives. By 2014 the government is projected to be paying more than $400bn annually in interest on the total debt, enough to fund the department of Veterans’ Affairs three times.

In addition to hitting primary balance in 2014 and full balance by 2020, two other measures are critical to get us back on fiscal track: specifying year-by-year steps towards those goals; and formulating a scheme to help Congress discipline its budgeting process. The former is straightforward; the latter, less so. Congress should start by passing strict pay-as-you-go provisions, which existed before the Bush administration and Congress allowed them to expire in 2002. The second step is to give the pay-as-you-go process teeth. That will include ensuring tax levels and loopholes, as well as spending, are included in rules that automatically adjust the budget in the event of excess deficit levels.

Almost everyone agrees running deficits of the size projected carries substantial risks. However, we should not jeopardise recovery by exercising fiscal retrenchment in the near term. Instead, policymakers must build a pathway that will facilitate the hard decisions required in the coming years to bring the federal budget back into balance.

Posted via email from Jim Nichols