Congress' deficit hawks seem to have gone missing in action

Congress' deficit hawks seem to have gone missing in action
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One has to regret that at the time that the country most needs them, Congress’ deficit hawks would seem to be missing in action. Not only does this risk putting the country’s public debt on the most dangerous of trajectories, it also heightens the risk both of a hard economic landing and of a widening in the country’s trade deficit.

Sound budget management demands that while in bad times the budget deficit might be allowed to increase to support the economy, in good economic times, every effort must be made to reduce the budget deficit.

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If the deficit is not reduced in the good times, the country’s public debt is bound to remain on an ever increasing path. That in turn would put at risk our children and our grandchildren’s future economic prosperity.

 

This consideration of prudent budget management alone makes it very difficult to understand why Congress’ deficit hawks now seem to be abandoning their principles of the need for disciplined budget policies. After all, unemployment has declined to around 4 percent, the economy is operating at or very close to its potential level, and the economy is humming along at a healthy pace. 

This would suggest that the economy is hardly in need of a fiscal stimulus at this particular juncture. By using up fiscal space now in the good times, one would be constraining the room for fiscal policy stimulus in the event of an economic recession down the road.

It is also difficult to understand why the deficit hawks seem to feel comfortable with the dangerous debt path that would result from an unfunded tax cut at this point.

As Alan Simpson and Erskine Bowles have correctly noted, the present tax reform bill is likely to result in an increase in the public debt over the next decade from anywhere between $1.5 and $2.2 trillion. This would result in the nation’s public debt-to-GDP ratio rising from its current, already high level of 75 percent to around 100 percent by 2027.

The deficit hawks would also seem to be minimizing how seriously a fiscal stimulus at this juncture will complicate the Federal Reserve’s task of normalizing monetary policy.

Even without the fiscal stimulus, it would seem that the Fed will be obliged to raise interest rates several times next year to counter the strong support that the economy is already getting from a booming stock market and a weaker dollar.

A fiscal stimulus now would require that the Fed raise interest rates at an even faster pace than it is currently contemplating.

There is reason to think that too rapid a rate of increase in interest rates could result in a hard economic landing. After years of ultra-easy monetary policy by the world’s major central banks, asset prices across the globe have become untethered from underlying economic fundamentals.

Global equity valuations today are at levels only experienced three times in the past 100 years, the global government bond market is in an unprecedented bubble, and housing prices are at lofty levels in many markets.

Past painful experience would suggest that should the Fed indeed be forced to raise interest rates rapidly to forestall inflation, we could have a major bust in asset prices that could have untoward economic consequences. One would think that this too should be giving the deficit hawks pause about going along with the tax cut bill.

Yet another reason why one would think that the budget deficit hawks would be more vocal now than before is the seeming urgency of the Trump administration to reduce the country’s trade deficit.

If one were serious about reducing the trade deficit, one would not be going along with a tax reform proposal that would almost certainly lead to a reduction in the level of the country’s saving.

Rather than reducing the trade deficit, one must expect that a reduction in the country’s savings level resulting from an increased budget deficit would increase the trade deficit and bring back the days of the twin deficit problem.

With so many reasons to be concerned about an increase in the country’s budget deficit, one must be highly disappointed in Congress’ erstwhile budget deficit hawks now seeming to abandon their principles. Hopefully it is not too late for them to change their minds.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.