Federal deficit falling fast: Is that a good thing ... or a bad thing?

New estimates show the US federal budget deficit falling faster than forecast. To some, that's a sign that fiscal policy is becoming too austere, valuing quick cuts over more-needed reforms.

By , Staff writer

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    Congressional Budget Office Director Douglas Elmendorf speaks at a news conference to release the CBO's annual "Budget and Economic Outlook" report on Capitol Hill in Washington earlier this year. A Congressional Budget Office study released Tuesday offers an improved outlook.
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A smaller federal deficit is welcome news, right? Well, make that maybe.

Some economists see a risk that, with the budget deficit now declining faster than expected, the result will be to further slow down an already tepid jobs recovery.

The idea is that, when the private sector is still struggling to create a lot of job-generating demand from consumers and businesses, government shouldn’t be tightening its spigots.

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Yet fiscal policy is getting tighter: The federal government is on track to spend $82 billion less this year than last year, while pulling $363 billion more in tax revenue out of consumer wallets.

“The [deficit] is coming down too fast given the still weak economy,” says Jared Bernstein, an economist and former Obama administration adviser, in his blog. “Moreover, both deficits and debt start to grow again later [in the decade]. So the deficit is falling quickly when it shouldn’t be and rising later when it shouldn’t be.”

New figures from the Congressional Budget Office show this year’s deficit on track to total $642 billion, down from a forecast of $850 billion three months ago.

A clear positive in that news is the slower buildup of national debt, as the CBO sees deficits falling in part due to a faster-than-expected rebound in tax revenues. That shift lightens the burden of debt to be financed by future American taxpayers.

But the optimum fiscal policy right now is a matter of sharp debate.

Some economists, including Mr. Bernstein of the liberal Center for Budget and Policy Priorities, emphasize the role that government policy can play in spurring demand during tough times. And they point to Europe, with its current combination of austerity and recession in a number of nations, as an example of the danger.

Others, while they approved of such fiscal stimulus during the depths of the recession in 2009, argue that now is an appropriate time to start ratcheting down historically high deficits.

Most forecasters agree on a couple of key points.

First, at some point deficits need to come down – notably by finding sustainable balance between the growth of entitlement spending and tax revenues.

Second, tighter fiscal policy this year is acting as somewhat of a drag on economic growth.

Economists at Goldman Sachs estimate that gross domestic product is growing at least 1 percentage point slower than it otherwise would this year, due to fiscal policies such as the expiration of a payroll-tax cut for workers and the enactment of a “sequester” that cuts federal spending.

This “fiscal drag” exceeds 1.5 percentage points of GDP in each of the year’s first three quarters, they estimate. Under current policies, the head wind will diminish to less than half a percentage point of GDP by the final quarter of 2014.

Despite the drag on growth, GDP expanded in this year’s first quarter at a 2.5 percent annualized rate, and many forecasters see a similar pace for the rest of the year.

But the unemployment rate remains high, at 7.5 percent, with 4.3 million Americans who have been jobless and seeking work for more than half a year.

That leaves some economists calling for a looser fiscal policy, while others argue that the current stance is about right, given the need to guard against too big a buildup of debt.

In this debate, even many “deficit hawks” argue against too sharp a tightening.

The nonpartisan Committee for a Responsible Federal Budget, for example, says that a successful plan could match long-term entitlement reforms with some easing of the sequester-related spending cuts in the near term.

That kind of balancing act appears to be preferred by many economists. In a poll of business forecasters last September, the general tilt was against tightening fiscal policy in 2013, but for tightening starting in 2014.

A USA Today poll of economists in February found that many see long-term deficit reduction as a plus for the economy in the short run. Fully 9 in 10 said that, if a “grand bargain” on deficit reduction is reached, it would make the economy at least somewhat stronger next year.

The CBO on Tuesday projected that, absent such a grand bargain, budget deficits will be greater than 3 percent of GDP in 2020 – and the national debt rising as a share of the economy.

The CBO said rising debt would mean less money is available for economy-boosting investments. That, in turn can mean slower wage growth for ordinary Americans. High debt also would heighten the risk of a fiscal crisis, like what some European nations have been experiencing.

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