Have We Solved Our Fiscal Problems?

by: Felix Salmon

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Ezra Klein has a good summary of the latest CBO budget projections, which show that the national debt really isn’t going to be a problem at any point in the foreseeable future. The deficit isn’t going away, of course: the smallest it’s likely to get, according to the CBO, is $378 billion, or 2.1% of GDP, in 2015. But that’s entirely manageable, and puts the national debt-to-GDP ratio on a pretty flat trajectory over the medium term.

Of course, in the real world, none of this is actually going to happen as forecast. It’s hard enough to forecast what’s going to happen in 2013, let alone what’s going to happen in 2023: the CBO projection for this year’s deficit has fallen from $845 billion to $642 billion just in the past three months, so it’s worth taking all future forecasts with a large pinch of salt — especially since the one thing that’s certain is that there will be substantial changes to US fiscal policy between now and 2023.

This chart contrasts quite dramatically with the bipartisan consensus that America’s national debt — and especially the way that it is built up by the entitlement programs of Medicare, Medicaid, and Social Security — are serious problems. As Paul Krugman explains wonderfully in his latest essay for the NYRB, America’s social safety net was actually a key channel through which countercyclical government stimulus entered the economy in the wake of the financial crisis. And given how difficult it is to legislate expansionary fiscal policy on the fly, there’s a strong purely economic case for keeping such programs.

With any luck, then, this chart will help us to stop bellyaching about the debt, and create a bit of space where we can try to work out how to really get the debt-to-GDP ratio down over the long term, by concentrating on increasing the denominator rather than decreasing the numerator. But don’t hold your breath. Even the CBO takes pains to warn of debt problems in the future, saying that a debt-to-GDP ratio around 75% “would have serious negative consequences” in terms of interest expenses, lower wages, and worse:

A large debt increases the risk of a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

In the USA, this risk is de minimis, barely even worth mentioning: not only do we print our own currency, but in general US government bonds are universally considered the safest assets on the planet. So what’s the CBO playing at, here?

Krugman has a fascinating explanation for what might be going on:

Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.

I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.

My opinion is that it’s even simpler than that. Krugman naturally sees macroeconomic problems in terms of cycles: there are booms and busts, and there are emotional reasons why economists prefer to concentrate on the problems with booms, and apply the solutions to those problems (spend less money) even during busts where they are contraindicated.

But I think the general view of the public, and of our mainstream elected representatives, is even simpler. These people aren’t economists, and don’t think in terms of cycles; they certainly can’t clearly articulate the difference between a financial crisis and a fiscal crisis. Everything just reduces to “we spent too much, we should spend less”, which makes intuitive sense: the biggest problem with Keynes is that, just like Ricardo, a lot of what he discovered is deeply counterintuitive.

In which case, Krugman’s cyclical arguments are not going to carry the day politically: it’s hard to explain that the right thing to do changes according to various measures of resource utilization. Instead, it might be best, on a tactical political level, just to point at the CBO’s debt-to-GDP chart and say look, we’ve solved this problem now. Even if the CBO wouldn’t really agree with that interpretation.