I lied when I said “…more in the morning”. It’s now around midnight the next day.
So, in the last post I was going over the reasons I was in favor of the Murray-Ryan budget agreement. I left off on reason #3. Let’s continue:
4. An easing of short-term austerity might not be a bad thing. This may surprise many people, but America has just undergone its most rapid fiscal contraction since World War 2. The budget deficit has fallen by a whopping $700 billion in the past 5 Fiscal Years, from $1.42 Trillion in FY 2009 to $680 billion in FY 2013. This equates to a fiscal contraction of approximately 6% of GDP. Thus, despite claims to the contrary, America’s annual fiscal situation is improving very quickly due to a combination of revenue increases (tax hikes + sluggish economic growth) and declining expenditures (spending cuts + cyclical declines in “automatic stabilization” spending). Now, generally I disapprove of using government manipulation of fiscal policy to try and “pump-prime” the economy, and I think that fiscal responsibility does yield long-term benefits. At the same time, however, the rapidity of the fiscal contraction that has been occurring over the past few years has almost certainly held back short-term economic growth (as higher taxes and lower spending bite into aggregate demand). While I’m not against continued moderate austerity, I am against austerity that is too aggressive and rapid, as there comes a point when deficit reduction starts to be cancelled out as overly-rapid austerity bites into economic growth. This is precisely what has happened in Greece, which (unlike America now) didn’t really have a choice as to whether to pursue austerity or not – I mean, it was literally being shut out of bond markets. We do threaten to turn into Greece, however, if our pace of fiscal contraction becomes too rapid. An easing of the pace of austerity that would come about upon enactment of the Murray-Ryan budget is thus potentially beneficial.
5. Immediate budget balance is not necessary for fiscal sustainability (even if eventual balance is desirable). Many people are alarmed by the existence of any annual budget deficit; after all, every annual budget deficit adds to the debt by the amount of the deficit, and continual additions to the national debt are bad, right? Actually, no. What really matters is the size of our national debt as compared to the size of our national economy and the pace of annual debt growth (our budget deficit) as compared to the pace of annual economic growth. Right now, when you look at our national debt of about $17.2 Trillion, it looks pretty scary. But absolute numbers are not as important as relative numbers. What matters is that $17 trillion as a ratio of the size of our economy, a figure that tells us how much of a relative burden that debt is and our national ability to service that debt. Right now, with an economy of about $16 trillion, our debt/GDP ratio is about 107%. Even this ratio is misleading, however. That $17 trillion debt figure is our total gross national debt; more important is the debt held by the public, which is the total debt minus intergovernmental holdings of debt (I’ll get more into these distinctions in a later post – look here for good definitions & information though :D) Using the debt held by the public figure, the debt/GDP ratio is lower at 73% – historically high, but not at crisis levels. It is only when this figure approaches higher levels (say, 100% of GDP +) that a fiscal crisis (characterized by serious spikes in interest rates) is a real danger. Due to continued economic expansion since June 2009 in combination with slower increases in debt (due to lower annual budget deficits), debt held by the public has stabilized as a percentage of GDP (around that 73% figure) – meaning our fiscal situation is as of now sustainable in the short run. Indeed, as long as the following conditions are met, our debt is sustainable: annual increases in debt are lower than or equal to our GDP growth and the debt/GDP figure isn’t already high. For now, this is the scenario we are in. In the long-run, though, rising entitlement & healthcare spending will drive up budget deficits to the point where debt accumulation again outstrips GDP growth, implying a rising debt/GDP figure and an unsustainable long-term situation. The Murray-Ryan budget deal, however, does not increase annual spending enough to have debt accumulation outstrip GDP growth in the short term, nor does it add to the long-term entitlement challenges I mentioned. If adopted, we will remain fiscally sustainable in the short to medium-term, even if our long-term prospects are shaky.
I’ll try delving even further into these complex debt & deficits concepts in a later post. Right now, it’s time for bed.
Charts, courtesy of the Heritage Foundation: