Economy Dodges Bullet but Deficits Loom
CUNA's chief economist gives his take on the budget standoff and the prospects for deficit reduction.
The federal government shutdown and budget debacle this fall led to a near miss for the U.S. and world economies, says CUNA Chief Economist Bill Hampel. Credit Union Magazine asked Hampel for his take on the budget standoff and the prospects for deficit reduction.
Q What do you think about the recent national debt ceiling debate in Washington?
A It was really unfortunate. If we had gone past the debt ceiling for more than a few months, the consequences would have been staggering.
The federal government would have been required to immediately balance its budget, resulting in spending cuts that would have caused a downward economic spiral.
Or, we could have defaulted on some payment obligations, like Social Security, Medicare, or debt payments. The resulting turmoil in financial markets also would have started a downward economic spiral.
Q Does that mean it’s futile to try to cut federal deficits?
A Not at all. In fact, over the next few years, even if we take no action, the deficit picture will improve dramatically. With the economy recovering and stimulus program expiring, deficits are falling rapidly, to 6.7% of GDP last year, 4.2% this year and next, and as low as 3% in 2016.
Q Wouldn’t we be better off if we always balanced the budget?
A Not necessarily. When the economy is strong, at full employment, we should run budget surpluses. When the economy is weak, as it still is, operating at a deficit is fine.
The trick, over time, is to keep the total national debt held by the public— the sum of all past deficits—to trend to something less than 50% of GDP. That’s largely been the case since the 1950s, but it rose to over 70% during the Great Recession (“National debt held by the public”).
The falling deficits of the next few years will be low enough for the ratio to begin to decline.
It’s important to consider that, unlike a household, the federal government does not have a finite life expectancy. Therefore, financial rules that apply to households, such as building net worth for retirement, don’t apply.
A government can stay in debt forever so long as the debt isn’t too high. An average annual deficit of 3% of GDP or less would be sustainable for the U.S. economy.
Q Does that mean all the concern about deficits is misplaced?
A Unfortunately not. The lower deficits of the next few years are just the calm before a building storm.
Toward the end of the decade, as more baby boomers retire, Social Security and Medicare—which make up about 50% of total federal spending—will rise dramatically, pushing annual deficits toward 5% of GDP even at full employment.
It will only get worse for the next two decades, and the ratio of debt to GDP could double by midcentury. This would be unsustainable.
Q Yikes! What can we do?
A Well, eliminating the old standbys of “waste, fraud, and abuse” won’t cut it. We’d have to eliminate either all discretionary nonmilitary spending, or all military spending, or cut each by half. That won’t happen.
Instead, we’ll need a balanced program. The particular mix of revenue increases and spending reductions varies according to political persuasion, but we need to start somewhere—and start soon.
We have a robust economy with a bright future. But if we wait for the debt to explode before tackling the long-term problem, it could be too late.