What’s Going On Here?

The title of this post refers not to our new blog – whose purpose is explained here– but rather to the fiscal issue itself.  Why do we care so much, when some others believe that the public debt is just a diversion?

The basic fact is that just about anyone or any group can accumulate so much debt as to become non-viable.  If actual and potential creditors conclude that a borrower cannot service his, her or its debts, then credit flows cease.  Those borrowers, which had relied on borrowing to finance their daily operations, can no longer operate.  Because they cannot service their debts, they default and go out of business.  It has happened to households.  It has happened to business firms.  And it has happened to entire nations – with the proviso that nations sometimes can pay their debts by printing so much currency that its value plummets, in a process widely known as hyperinflation.

Even short of that extreme, households, businesses and nations can become so heavily indebted that the cost of servicing their debts inhibits their ability to perform their fundamental missions.  Their stakeholders suffer.  For households, the result can be poor nutrition, inadequate health care, and stress.  For businesses, it can be reduced wages that drive away the best workers, or inadequate investment that leads to inferior products or to a cycle of higher costs that still further constrain investment.  A nation can suffer much like a household or a business: inadequate, crumbling infrastructure; poor nutrition, health care and education for many in the population; and even declining national security.

The United States is well along that path toward fiscal and financial decline.  Our public debt is the seventh highest in the developed world.  All six countries with higher debt are under conspicuous pressure – as are several with lower debt loads.  We continue to attract credit from overseas – three-fifths of our net new borrowing – because we remain for the moment the world’s largest economy, and the rest of the world assumes that in the end we will do the right thing, as we always have in the past.  But still we procrastinate.  We are living off of our reputation, while our behavior threatens to destroy it.

The participants in this blog want this nation to change its behavior, and do the right thing.

But there are those who look at the nation  and see first another problem: the weakened economy in the wake of the financial crisis of the last decade.  That problem is not easy to miss.  One in six adults remains unemployed, working only part-time because full-time work is not available, or too discouraged even to look for work.

Some commentators and economists – notably Paul Krugman of the New York Times – see those who worry at the rising debt as misguided, or worse.  To them, economic weakness and its human cost are so great that concerns about debt should be shelved.  Fix the economy first; there will be plenty of time to think about the budget later.

But the interaction of those two problems causes a true dilemma.  The forget-the-deficit, mind-only-the-economy view is naively academic.  To that school of thought, life is a multiple choice examination: one answer is right, the other is wrong.  “Question: What one policy will solve all of our nation’s problems and lead us all to live happily ever after: (A) Stimulate the economy; or (B) Reduce the budget deficit?”  “Uh, uh, B – Reduce the budget deficit.”  BUZZZZ!  “Wrong answer!  Ha!  You fail!  You would have destroyed the entire U.S. economy!  Next student!  Remember that this question is 60 percent of your final grade!”

Most of the serious questions in life are more complicated than that.  Take medicine as an example.  You need to take a medication to control your heart condition.  But you cannot take that medication because with your diabetes, your system cannot tolerate it.  Catch-22.

Likewise the economy and the debt.  There is no single complete and correct answer.  And in fact, it is well within the realm of possibility that there is no satisfactory answer.  The monomaniacal stimulus group says that there will be no budget solution without solid economic growth.  Fair enough.  But there may be no strong economic growth with a debt burden as large as ours shortly will be, bringing a loss of our nation’s financial credibility and debt service costs that either crush or slowly strangle the economy.  The two preconditions of economic growth and healthy credit markets to finance that growth may not be attainable together, so sorry is our current state.  They will be at least extraordinarily difficult to reconcile.

Resolving this dilemma will require nurturing a shaky economic recovery in the near term.  But it also will require sending our creditors an unmistakable message, at the earliest possible moment, that we recognize our fiscal problem and have concrete plans to solve it.

Making the actual transition from stimulative policy to budget control will be a true challenge.  Reducing the deficit will unambiguously restrain growth, and the debt is so large, and growing so fast, that the transition from stimulus to restraint cannot be put off for long.  Squaring this circle surely will require the clearest understanding between the White House and the Congress, on the one hand, and the Federal Reserve, on the other.  The Fed will need to unwind its current extraordinary stimulus later and more gradually than it otherwise would have planned.  To hold back on reversing its policy, the Fed will need concrete assurance that the budget will be restrained.  That bargain will be private and implicit, as such past understandings invariably have been.  The best way to strike that bargain will be for the Congress and the President to reach a bipartisan agreement for a shift of policy scheduled for one or two years down the road.  The prospective effective date will give the Fed the opportunity to plan ahead; the bipartisan agreement will create the best possible assurance – though not certainty – that the policy will not change because of the outcome of a future election.

If George Balanchine were still alive, he certainly should have been engaged to choreograph our macroeconomic policy exit from this dilemma, delicately coordinating the monetary policy of the Federal Reserve and the fiscal policy of the Congress and the White House to maintain a shaky economic recovery while also reestablishing our fiscal credibility.  It will be perhaps the most complex pas de deux in our economic history.

The one clear lesson from this economic predicament is never to allow our nation to fall into such an economic predicament.  And the key unforced error bringing us to this predicament is debt.  We could respond to this economic weakness without hesitation were our debt not already well into the red zone.  So our debt is not only a direct threat to our economy, but also a constraint on sound policy to respond to economic weakness from other sources.  The sooner we plan seriously to address the budget problem – in a measured way that is chosen to maintain economic growth – the better the job can be done.

1 comment
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