No Contradiction between Fiscal Stimulus in the Short Run and Fiscal Sanity in the Long Run

In his meeting with Congressional leaders last week, President Obama heard from senior Republican House lawmakers about the risk of the long-term federal deficit. This was coupled with a claim that “Washington cannot keep spending money that we do not have” and a plea that no tax be increased until the unemployment rate falls below 5%. The GOP leaders’ stated fears about the long-term deficit are certainly justified, and these fears are shared by the President. It is dubious, however that we cannot increase the deficit in the short run while simultaneously taking credible action to reduce the long-term budget imbalance. In fact, taking both kinds of actions at the same time would improve both the short-term and long-term economic outlook. Whether this combination of measures is politically achievable is much more doubtful.

In the near term the government must boost spending or reduce taxes in order to spur faster economic growth and deal with the fallout from a severe recession. Large-scale fiscal stimulus would be unnecessary if the Federal Reserve still had scope to reduce short-term interest rates, but it does not. Short-term rates have been kept close to zero for the past year, giving the Fed little additional scope for using traditional monetary policy to encourage faster growth. 

Under these circumstances it makes sense to use fiscal policy to induce higher public and private spending.  Private sources of demand are very weak. Judging by current interest rates on Treasury debt, both American and overseas investors believe the U.S. government is highly creditworthy, notwithstanding some very silly claims by opponents of the Administration’s policies. This means there is still scope for the government to borrow funds for added humanitarian relief to the unemployed, fiscal relief to state governments, and investment in public infrastructure.

Of course, investors would be much more impressed by the creditworthiness of the government if we took credible steps to reduce the long-term federal deficit.  Most of the growth in the long-run deficit is traceable to a single, widely recognized development:  Spending on health care, much of it funded out of the federal budget, is growing much faster than the overall economy. To be sure, some of the future rise in health spending will be fueled by population aging, and this is unavoidable.  An older population will be sicker and will require more health services than a younger one. The burden of population aging would be much easier to deal with, however, if the nation did not also face the relentless claims of ever rising medical care prices. To keep health care (and federal health insurance costs) affordable in the long run, the nation must reorganize insurance and the provision of care to reduce wasteful spending on administration and on care that offers less benefit than it costs.

Both the health reform bill passed by the House and the one making its way through the Senate contain valuable cost-saving measures. CBO analysis suggests, however, that these measures represent baby steps along the path to future budget balance. More dramatic steps will be needed to slow the growth in future health spending to a pace that is sustainable given the likely growth of the overall economy. If Congress cannot wring more future cost savings out of federal health programs, it must identify a source of funds to pay for much higher future costs. In other words, it must pass laws to boost future taxes or insurance premiums. Alternatively, it must identify some part of the federal budget that will be scaled back in order to make room for the increasing claims of health care. Any of these steps could be taken immediately to deal with the nation’s long-term budget problem. There is no contradiction between taking these steps and providing additional short-term stimulus to boost the economy. We do not need to cut spending or boost taxes next year or the year after.  Nonetheless, the legislation passed in the near-term should chart a credible path to sustainable deficits in the not-too-distant future.

I am not naïve. It can be politically fatal to take steps that will credibly reduce the long-term deficit. The budget agreements in 1990 and 1993 show that these steps are not impossible. The electoral aftermath of those two agreements reminds us of the price politicians sometimes pay for acting responsibly, however.  George H.W. Bush lost his next election after the 1990 agreement, and Congressional Democrats lost their majorities in both the House and Senate after the 1993 agreement. It is far easier to compose wise editorials than it is to cast a vote that might end a political career.