Rapid Deficit Reduction Won't Bust US Economy

MY purpose is to assure the faint of heart that planned reductions in federal-government spending will not excessively depress the economy. Because of historical experience, it is hard to take the concern seriously. The US has experienced 14 consecutive federal budget deficits of triple-digit magnitude, measured in billions of dollars, despite the Gramm-Rudman-Hollings law and more-recent budget ''summits.''

The Republican leadership proposes eliminating the budget deficit by fiscal year 2002 through reduced federal spending amounting cumulatively to $1.247 trillion. The cynic would assume that the small cuts will be made now and the large cuts much later. Surprise of surprises, that is the idea.

Plans call for reducing federal outlays by $41 billion from the Congressional Budget Office's baseline budget for fiscal year 1996 and by $79 billion in 1997. Does anybody believe that the $7 trillion US economy is so frail that cuts of these modest proportions (1 percent or less of estimated gross domestic product) will bring it crashing down? In later years, however, the proposed reductions become much more substantial, attaining $278 billion in fiscal 2001 and $348 billion in 2002 (equal to 2.9 percent and 3.5 percent of projected GDP respectively).

It is important to understand the nature of federal fiscal arithmetic. In the face of apparently massive reductions totaling $1.247 trillion over the period 1996 to 2002, federal spending is expected to rise from $1.518 trillion in fiscal 1995 to $1.876 trillion in 2002. That increase more than offsets expected inflation.

Most budget cuts occur in entitlements and interest, which are virtually pure consumption. The remainder of the reductions is not specifically identified and is likely to be distributed across various federal programs. But it is easy to see where most of the cuts will go, because consumption outlays dominate the entire federal budget. By mainly cutting federal consumption spending, the proposed reductions in deficit financing respond to the widespread concern about inadequate saving and investment in the United States.

If historical experience is any guide, the result of lower deficits should be an increase in private investment and hence in the economy's long-term growth rate. The CBO makes the same point: ''The progressive elimination of the federal government's competition for funds in private capital markets would lower interest rates and slightly increase the potential growth of the economy over the next decade.''

As in the case of any major change in economic policy, attention must be given to the transition period during which the economy is adjusting to the change. The budget cuts rise to the range of $50 billion to $70 billion a year around the turn of the century. At most, that equals a bad, but not disastrous, year in housing construction or automobile production. Such magnitudes of change should be readily handled in what will then likely be a $9 trillion to $10 trillion economy.

It is reasonable to assume that the Federal Reserve System will not be idle during this period. Here is a special advantage of the planned reductions in Treasury borrowing. The Fed can anticipate them and crank them into its calculations.

Long-term government policies, however, are rarely carried out without substantial modification during the course of their execution. The task of economic stabilization in the next six years may be less than it appears to be. A cynic would apply a substantial discount to the future budget cuts. As progress is achieved in deficit reduction, urgency to complete the task may diminish. Pressure groups pushing for larger government programs may reassert their political power, especially as public attention is shifted from balancing the budget to some newer and perhaps more dramatic priority.

The attractiveness of government spending is almost always very high to the recipient. After all, every dollar the government spends winds up as a dollar of income to somebody. That is why the annual battle of the budget is always predictably ferocious.

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK