For those of us who grew up during the Cold War, the movie “Dr. Strangelove: or How I learned to Stop Worrying and Love the Bomb,” was a wakeup call to the threat of nuclear annihilation. Today, the debt crisis poses a different kind of threat, but one that seems to have disappeared from public debate. Citizens and elected officials have become unconcerned about public debt because Keynesian economics continues to dominate public discourse.
Paul Krugman, a proponent of Keynesian economics, argues for complacency toward public debt. He criticized President Obama for not pursuing more fiscal stimulus during the financial crisis, despite trillion-dollar deficits and a doubling of the national debt. Krugman, as well as other Keynesians, argue that the United States is experiencing secular stagnation, an idea that can be traced back to John Maynard Keynes and his disciples during the Great Depression. Keynesians maintain that fiscal stimulus is now needed to restore long-term economic growth.
Krugman maintains that with secular stagnation there is “even less reason than before to obsess over government debt.” He suggests that “Debt is way-way down on the list of things to worry about, absolutely trivial compared with, say, crumbling infrastructure, which should be fixed without worrying about paying as you go.” In “Dr. Strangelove,” Slim Pickens rides a nuclear weapon into oblivion; Dr. Krugman wants us to ride Keynesian fiscal policy into economic oblivion.
For too long, our elected officials have drunk Keynesian Kool-Aid. This year, Congress passed tax cuts and spending increases that will add $2.4 trillion to the national debt over the next decade.
The Office of Management and Budget published the President’s Fiscal Year 2019 Budget. OMB projected a 3 percent growth rate, and claimed that debt as a share of GDP will decline over the next decade. This forecast of a 3 percent growth rate is at odds with most public and private forecasts of economic growth. The Congressional Budget Office Long Term Forecast assumes a growth rate of less than 2 percent over the next two decades. The CBO forecasts that under current law the debt/GDP ratio will increase at an unsustainable rate, and that higher debt/GDP ratios will result in retardation and stagnation in economic growth. The CBO concludes that because of this increased debt burden, the United States is increasingly vulnerable to recessions and other economic shocks that could trigger a debt crisis.
In our research, we use a dynamic simulation model to explore how fiscal rules, such as the Swiss debt brake, can be used to address the debt crisis. The analysis reveals that if we immediately enact these rules we could close the fiscal gap, i.e. stabilize the debt/GDP ratio at current levels, over the next two decades. To reduce debt to sustainable levels would require very stringent fiscal rules, combined with about $800 billion in savings from entitlement reform, federal asset sales and privatization each year over the forecast period.
To test the vulnerability of the economy to economic shocks, we estimate the impact of a mild recession. Assuming that our proposed fiscal rules are in place, the government could use non-discretionary fiscal policy, i.e. automatic stabilizers, to respond to recessions, and still close the fiscal gap by the end of the forecast period. Using non-discretionary fiscal policy to respond to recessions is the fiscal policy Milton Friedman advocated a half-century ago.
Our research reveals that the United States is now extremely vulnerable to major economic shocks, such as the financial crisis. Even with our proposed fiscal rules in place, the federal government does not have the fiscal space to use fiscal stimulus the way that President Obama did during the financial crisis. Pursuing such Keynesian fiscal policies now would make it impossible to close the fiscal gap, and would expose the economy to the kind of debt spiral that Krugman dismisses.
The United States cannot muddle along with current fiscal policies and postpone addressing the debt crisis indefinitely. The economy is now vulnerable to recessions and economic crises, and we can’t assume that economic growth will make the debt crisis go away. President Trump and Congress will probably have to address the debt crisis sooner than they think.
John Merrifield is Professor of Economics at the University of Texas San Antonio
Barry Poulson is Emeritus Professor at the University of Colorado Boulder
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