AUTHOR: Steve Redburn, Project Director, Peterson-Pew Commission on Budget Reform
Diving into the complexities of how to deal with the federal budget’s fundamental imbalance, it possible to drown in its details. People construct metaphors as an antidote (note metaphor) for excessive complexity. But, these mental devices can oversimplify and distort as easily as enlighten. What is the right metaphor to fit the fiscal challenge we now face? Are we on a falling airliner, lost in a fiscal maze, or drowning in a sea of debt?
None of these quite works, it seems; but we are a bit at sea. I find the shortest route to understanding the fiscal challenge is a nautical metaphor. If the federal government were a big ship it would be headed for the rocks. Its fiscal course is unsustainable. It must change course.
Within limits, this metaphor illuminates essential features of the fiscal challenge. First, there is the obvious danger that a ship headed for the rocks will either founder or run aground. That is, the voyage could end in a fiscal charybdis of rising debt and rising deficits, fed by higher interest rates as creditors circle. As an example, look at what is happening in Greece now. Or, the ship could simply run aground, our economy stagnating for a decade or more as Japan’s has done. The risk and economics of both possible outcomes are discussed in the NRC-NAPA study report, Choosing the Nation’s Fiscal Future.
The study also has some metaphorical good news for captain and crew. Based on the best calculations, there is not only still time to alter course, but many possible routes away from danger. The report details some big policy changes that would contribute to turning the ship, and how they could be combined to move us to safer waters.
The nautical metaphor also highlights other characteristics of the fiscal challenge central to understanding how and when we should respond:
- First, it must be observed that it takes a long time to turn a big ship like the federal budget. The sooner we start to turn away from danger, the less abrupt the turn. Wait a few years longer and some valuable cargo or people may get tossed overboard, and others will get sea sick as their favorite public programs are trimmed or dreams deferred. But, some have expressed concern that too abrupt a change could pitch the economy into another downturn. One reason the course change may be uncomfortably sharp is that we have already passed the time when a more gradual turn would steer us safely away from danger and must wait a bit longer because of the fragile economy. The study committee recommended that a course change not begin until 2012; it assumed that by then the economy is rising strongly. Its benchmark for judging the practicality and risks of its proposed turn was that made in 1993 with adoption of the Clinton Administration’s economic plan and budget. Compared to then, the proposed change would be about twice as large in the first year (1.1 percent vs. 0.5 percent of GDP) but nearly the same by the fifth year. In the 1990s, the course change was followed by robust economic growth, aided by declining interest rates. But, of course, experience is an imperfect guide in such cases; for example, interest rates are now so low that there is little room for the Federal Reserve to push them lower to counterbalance tighter fiscal policy.
- A major determinant of how sharp the fiscal turn must be is how far clear of the reef of excessive debt the fiscal ship should steer. The NAPA-NRC study committee (including several salt-encrusted former captains) decided the publicly held federal debt should be stabilized at no more than 60 percent of the nation’s GDP over a decade. Others have proposed getting there sooner (see, for example, http://budgetreform.org/document/red-ink-rising). The change would be much less abrupt if, as some advocate, the decision was to carry a permanently higher debt. Some have proposed 70 percent, for example (to sample their arguments see http://www.fiscalhighroad.org and http://www.cbpp.org/research/index.cfm?fa=topic&id=121); a level of borrowing that the Government is projected to reach within the next year or two.
- But, carrying a larger debt burden not only means servicing a larger debt before spending on the nation’s needs; it also takes a greater risk – the risk of running close to a lee shore, where a stray current or sudden gust could toss the ship and all aboard on the rocks. Deciding how much debt it is safe to carry is not exact science, but a question of prudence in the face of uncertainty. What is this risk exactly? In this downturn we saw how quickly our debt burden could rise – from 40 percent of GDP to now over 60 percent and now projected by CBO to reach 90 percent of GDP by 2020 under the President’s proposed policies. The longer we run a high debt, the longer we run the risk that a shock of similar size – another economic crisis, war, a huge natural disaster, or another unforeseen emergency – would demand additional spending and therefore the piling up of more debt. Higher debt affects the perceptions of investors in our debt about our ability to stabilize the fiscal ship and therefore causes them to demand higher interest rates. This size of this effect is hard to estimate, but research cited by the NRC-NAPA study suggests it could be a significant additional interest burden, making it harder not only to carry a given debt but to find resources for public investments needed to sustain growth and meet future commitments. The potential is there for a downward spiral of deficits, higher interest, and higher debt.
We shouldn’t get carried away with our metaphor. For one thing, a ship only has one captain. A democracy has many, or none. Leaders will be unable to act unless they are able to gain wide public understanding of the risks and costs of not acting and majority agreement on, or at least acceptance of, a new course.
By the way, what is that on the horizon?
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