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So are we really going to do this? Is the United States, the world’s most important economy, really going to thoughtlessly stumble into a novel experiment in fiscal policy? Massive fiscal stimulus at this point in the business cycle?
Apparently so. Even before Trump’s tax cuts, America’s debt-GDP ratio was projected to rise to 91% of GDP over the next decade from around 77% currently and 35% before the Great Recession. Now factor in the tax cuts and this new budget deal and — assuming what’s temporary is made permanent — the debt burden would reach 109% of GDP in 2027, “higher than the previous record of 106% of GDP set just after World War II,” notes the Committee for a Responsible Federal Budget. And trillion-dollar deficits as far as the eye can see. Up, up, and away.
Far less visible is any political will to do anything about this fiscal situation, including middle-class entitlement spending. So a reminder (one that precedes the recent passing of tax cuts and spending increases) on the potential downside of debt from the CBO:
Large and growing federal debt over the coming decades would hurt the economy and constrain future budget policy. The amount of debt that is projected under the extended baseline would reduce national saving and income in the long term; increase the government’s interest costs, putting more pressure on the rest of the budget; limit lawmakers’ ability to respond to unforeseen events; and increase the likelihood of a fiscal crisis, an occurrence in which investors become unwilling to finance a government’s borrowing unless they are compensated with very high interest rates.
So that’s the downside long-term. Shorter-term negatives would be higher inflation and interest rates, the fear of which is perhaps driving the recent stock market swoon. But is there potential upside here, at least in the short term, for pressing on the accelerator more than 100 months into the expansion? Perhaps. Maybe running a “high pressure” economy is just what’s needed after a sluggish, post-financial crisis recovery where economic and income growth has been tepid. The new issue of The Economist walks right up to making that case and then stops short:
First, it is far from clear that the economy is at full employment. Policymakers tend to consider those who have dropped out of the jobs market as lost to the economy for good. Yet many have been returning to work, and plenty more may yet follow. Second, the risk of a sudden burst of inflation is limited. Wage growth has picked up only gradually in America. There is little evidence of it in Germany and Japan, which also have low unemployment. The wage-bargaining arrangements behind the explosive wage-price spiral of the early 1970s are long gone. Third, there are sizeable benefits from letting the labour market tighten further. Wages are growing fastest at the bottom of the earnings scale. That not only helps the blue-collar workers who have been hit disproportionately hard by technological change and globalisation. It also prompts firms to invest more in capital equipment, giving a boost to productivity growth.
To be clear, this newspaper would not advise a fiscal stimulus of the scale that America is undertaking. It is poorly designed and recklessly large. It will add to financial-market volatility. But now that this experiment is under way, it is even more important that the Fed does not lose its head.
So time for stimulus? Maybe? One centered around tax cuts and defense spending rather than, say, infrastructure spending? No. I think that’s the magazine’s point. Then again, at least in the US, it seems the labor market was already at a turning point. So maybe history repeats itself in that this stimulus, like so many others, fails the test of being timely, targeted, and temporary. It is none of these things.