Fiscal stimulus is back. So are bigger deficits.

A rapid increase in federal debt is likely to push up interest rates and risk choking the current economic expansion. This could lead to a reckoning when debt payments start to pile up after 2019. 

Andrew Harnik/AP
The Capitol Dome of the Capitol Building is seen at sunrise Feb. 9 in Washington. After another government shutdown, Congress passed a sweeping, long-term spending bill that President Trump signed on Friday.

In piling a huge spending bill on top of a huge tax cut without the requisite revenues to pay for either one, US policymakers are putting extraordinary faith in the economy. They’re hoping it will grow so fast that it keeps a swollen national debt from getting worse.

They can point to signs of economic strength behind their faith: After nine years of expansion, business is booming and unemployment rates are near rock-bottom.

But economists and investors fret that the federal government is adding stimulus at exactly the wrong time in the economic cycle, just when it is near or at the top of its expansion with nowhere to go but down. 

“The economy's going to be running hot,” says Mark Zandi, chief economist of Moody's Analytics, a risk-management subsidiary of Moody’s Corp. in New York.

And federal budget-watchers are appalled. “It is hard to think of a time when there was less budget discipline than there is right now,” Alan Auerbach, an economist at the University of California at Berkeley, writes in an e-mail.

Budget experts calculate the United States is headed for $1 trillion-plus deficits, reminiscent of Obama's first term before the economic recovery took hold. Except this time, those deficits would be permanent, ballooning the federal debt and causing interest payments to eat up more government revenues, leaving less to spend on other priorities. 

If Congress makes permanent the temporary tax cuts for individuals and doesn't ratchet down its spending after the new two-year budget plan expires, annual deficits could swell to $2 trillion a year in a decade, says Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a bipartisan watchdog group.

One bright spot is that most economists don't foresee any immediate crisis of confidence in the US Treasury. And Congress has in the past successfully dealt with budget problems – at least when pushed by circumstances. Moreover, the likelihood of increasingly violent hiccups in the economy and the markets – US stock prices fell more than 10 percent last week – will eventually force policymakers to focus on the rising debt, some economists say.

“There are natural self-correcting mechanisms in the economy,” says Diane Lim, principal economist at The Conference Board, a business membership and research group based in New York. “What’s going to happen is one day interest rates will start to dramatically rise and that will scare everyone off enough that they'll just have to get their act together. Congress won't be able to ignore it anymore.”

Where interest rates go next

Interest rates may well be the pressure point.

Fear of rising US interest rates – in response to inflation fanned by Congress – were at least partly responsible for the sudden plunge in US stock markets this month. Taking a cue from the US, global stock prices have see-sawed wildly as traders have tried to sort out the short- and medium-term implications of Congress's spending package.

Through 2019, the extra stimulus should boost the economy, economists say. Tax cuts make the US a more competitive place for corporations to set up shop. The spending package means nearly $90 billion in disaster aid for communities hit by wildfires or hurricanes, a massive boost in military spending, the renewal of large health-care programs for low-income children and adults, and billions of dollars in extended business tax breaks. The threat of another government shutdown has been averted for a year under a bipartisan agreement.

“The market is overreacting,” says Jared Bernstein, an economic adviser in the Obama administration and now senior fellow at the liberal Center on Budget and Policy Priorities. “There are people in this economy that have not been reached. This extra spending can bring down the unemployment rate.”

Both sides of the aisle may be able to take credit if annual growth rises above 3 percent, a clip last seen in 2005. The same goes for unemployment, now at 4.1 percent, should it fall into 3 percent territory. 

Only after 2019 are the problems with Washington’s deficit strategy likely to emerge.

All that increased government spending raises interest rates in two ways: More borrowers are competing for a relatively fixed amount of credit; and the US Treasury must sell more bonds to a fixed number of buyers.

White House Budget Director Mick Mulvaney – a former fiscal hawk in Congress – concedes this risk but says tax cuts will help to sustain business spending even if borrowing costs rise. “If we can keep the economy humming and generate more money for you and me and for everybody else, then government takes in more money and that’s how we hope to be able to keep the debt under control,” he told “Fox News Sunday” yesterday. 

Most economists reject Republican claims that the tax cut will create so much extra economic activity that it will pay for itself through more tax revenues.

On Monday, the Trump administration seemed to acknowledge a starker view of the spending pressures, presenting a budget plan that would not eliminate the deficit in 10 years, unlike the plan it presented a year ago, which forecast a $16 billion surplus in 2027.

Timing matters

Also, the tax cuts and spending package look particularly ill-timed, economists say. Unlike President Ronald Reagan’s tax cuts in the 1980s and President Barack Obama’s recessionary stimulus package in 2009, which primed the pumps at or near the bottom of economic cycles, the current stimulus comes when the economy is running at capacity – or hot, as Mr. Zandi puts it.

“It’s in this hot environment that the odds are that it overheats – that interest rates rise too far too fast, undermine stock prices and real estate values, and lay the foundation for a very weak economy or even a recession early in the next decade,” he says.

At the very least, this complicates the work of the Federal Reserve, which since 2015 had been raising record-low interest rates slowly to head off inflation without triggering a recession. Now, the Fed may have to raise interest rates faster.

This isn’t the first time government has piled stimulus spending onto a booming economy. In the 1960s, after a tax cut under President John Kennedy, President Lyndon Johnson increased spending for his Great Society programs and the war in Vietnam. For a while, the economy kept humming. But inflation surged near the end of the decade and by the early 1970s the economy had gone into a tailspin, with inflationary pressure that took another decade to snap.

“A lot of our clients are kind of wondering whether this mix of policies that we’re pursuing now will set up an episode something like what occurred in the late 1960s,” says Joel Prakken, chief US economist of IHS Markit.

Economists caution that the economy’s future course is uncertain because policies can change. Out of the economic turmoil of the 1970s came two important changes. Congress passed the Congressional Budget Act of 1974, giving itself an equal role as the president in shaping the federal budget and creating the procedures for budget agreements. The second was the arrival of Paul Volcker at the Fed, who jacked up interest rates in the early 1980s, conquering widespread inflation and establishing the Fed’s inflation-fighting credentials.

What’s needed now is for Congress to fashion new procedures for budgetmaking, so that today’s extreme partisanship doesn’t derail the process, says Bill Galston, a senior fellow at the Brookings Institution, a Washington think tank.

When will Congress address the larger issue of the debt? Unless the optimists are right and economic growth can keep the debt-to-GDP ratio from rising, the day will come when lawmakers make debt-reduction a priority. 

“It’s just becoming a taller and taller order for the economy to grow faster than debt,” says Ms. Lim of the Conference Board. “We haven’t been able to do that ever since we started running up the deficits in the 2000s.”

– Monitor Staffer David Sloan contributed to this article from Washington. 

You've read  of  free articles. Subscribe to continue.

Dear Reader,

About a year ago, I happened upon this statement about the Monitor in the Harvard Business Review – under the charming heading of “do things that don’t interest you”:

“Many things that end up” being meaningful, writes social scientist Joseph Grenny, “have come from conference workshops, articles, or online videos that began as a chore and ended with an insight. My work in Kenya, for example, was heavily influenced by a Christian Science Monitor article I had forced myself to read 10 years earlier. Sometimes, we call things ‘boring’ simply because they lie outside the box we are currently in.”

If you were to come up with a punchline to a joke about the Monitor, that would probably be it. We’re seen as being global, fair, insightful, and perhaps a bit too earnest. We’re the bran muffin of journalism.

But you know what? We change lives. And I’m going to argue that we change lives precisely because we force open that too-small box that most human beings think they live in.

The Monitor is a peculiar little publication that’s hard for the world to figure out. We’re run by a church, but we’re not only for church members and we’re not about converting people. We’re known as being fair even as the world becomes as polarized as at any time since the newspaper’s founding in 1908.

We have a mission beyond circulation, we want to bridge divides. We’re about kicking down the door of thought everywhere and saying, “You are bigger and more capable than you realize. And we can prove it.”

If you’re looking for bran muffin journalism, you can subscribe to the Monitor for $15. You’ll get the Monitor Weekly magazine, the Monitor Daily email, and unlimited access to CSMonitor.com.

QR Code to Fiscal stimulus is back. So are bigger deficits.
Read this article in
https://www.csmonitor.com/USA/Politics/2018/0212/Fiscal-stimulus-is-back.-So-are-bigger-deficits
QR Code to Subscription page
Start your subscription today
https://www.csmonitor.com/subscribe