The era of fiscal austerity is over: What big deficits mean for US economy

The last seven weeks amount to a sea change in United States economic policy. The era of fiscal austerity is over, and the era of big deficits is back. The trillion dollar question is how it will affect the economy.

 

In the short run, expect some of the strongest economic growth the country has experienced in years, and some subtle but real benefits from a higher supply of Treasury bonds in a world that is thirsty for them.

 

In the medium run, there is now more risk of surging inflation and higher interest rates — fears that were behind a steep stock market sell-off in the last two weeks.

 

In the long run, the United States risks two grave problems. It may find itself with less flexibility to combat the next recession or unexpected crisis. And higher interest payments could prove a burden on the federal Treasury and on economic growth. This is particularly true given that the ballooning debt comes at a time when the economy is already strong and the costs of paying retirement benefits for baby boomers are starting to mount. It’s hard to overstate how abrupt the shift has been.

 

When the Congressional Budget Office last forecast the nation’s fiscal future in June, it projected a $689 billion budget deficit in the fiscal year that begins this coming fall. Analysts now think it will turn out to be about $1.2 trillion.

 

One major reason is the tax law that passed on December 20, which is estimated to reduce federal revenue by about $1.5 trillion over the next decade, or $1 trillion when pro-growth economic effects modelled by the congressional Joint Committee on Taxation are factored in. A budget deal passed in the early hours of Friday morning includes $300 billion in new spending over the next two years for all sorts of government programs and $90 billion in disaster relief, without corresponding cuts elsewhere in the budget.

 

It is a stark reversal from 2010 to 2016, when congressional Republicans insisted upon spending cuts and the Obama administration insisted on raising taxes (or, more precisely, allowing some of the Bush administration’s tax cuts to expire). Those steps, combined with an improving economy, cut the budget deficit from around 9 per cent of GDP in 2010 to 3 per cent in 2016.

 

In almost any economic model you choose, the new era of fiscal profligacy will create a near-term economic boost. For example, Evercore ISI, the research arm of the investment bank Evercore, estimates that the combination of tax cuts and spending increases will contribute an extra 0.7 to 0.8 percentage points to the growth rate in 2018, compared with the policy path the nation was on previously.  © 2018 The New York Times News Service