Milken Institute Hosts Panel on the National Debt's Impact on the Economy

On Tuesday, May 3, the Milken Institute hosted a panel discussion entitled “The Road Ahead: The Impact of the National Debt on America’s Economy” as part of its 2022 Global Conference. The panelists included Phillip Swagel, director of the Congressional Budget Office; Stephanie Kelton, professor of economics and public policy at Stony Brook University; Douglas Holtz-Eakin, president of the American Action Forum; and Jason Furman, Aetna professor of the practice of economic policy at Harvard University and former chairman of the White House Council of Economic Advisors. Josh Barro, host of the “Very Serious” podcast and author of the “Very Serious” Newsletter, moderated the discussion.

Barro opened the panel by noting that the choices policymakers make impact interest rates and inflation and that interest rates and inflation in turn affect the federal budget. Swagel agreed and mentioned that revenues are strong - stronger than would be predicted by the state of the economy - which reflects, to some extent, high inflation or the forces behind high inflation. At the same time, however, spending is up so the higher revenues and higher spending offset one another. Therefore, the fiscal dangers we face lie in interest rates; that is, an increase in interest rates will make the fiscal situation much more challenging. Higher interest rates mean higher net interest costs as debt rolls over.

Holtz-Eakin argued that debt as a share of Gross Domestic Product (GDP) needs to come down because a higher interest rate environment means the sustainable debt-to-GDP ratio is lower. He's quite concerned that throughout the first two decades of the twenty-first century debt-to-GDP has risen steadily and there hasn't been any degree of political accountability to stabilize it. Stabilizing debt-to-GDP will free up more resources to make more productive investments in the future. 

The conversation then moved to what it means in the current constrained environment of high inflation and high interest rates to try and establish new government programs. Kelton argued that some of the rhetoric around what policies to implement has shifted to a focus on available capacity. The closer the economy gets to full employment, the less real resources are available for the government to mobilize and the more difficult it becomes to spend into the economy without offsetting that spending. Kelton noted that potential offsets could be fiscal, such as spending reductions and/or tax increases, but that there are also ways to offset spending and free up capacity with non-fiscal pay-fors. She mentioned doing something on the regulatory side, such as pulling permits that stop some sort of activity from taking place, to free up resources for something else. Kelton thinks Medicare for All is a good example of a way to generate capacity because it would displace a lot of the current uses of labor and other physical capacity. 

Barro then asked Furman how much room there is for the economy to grow its way out of the inflation crisis. He noted that supply-side policies are worth pursuing in their own right, but there is little hope that they will have any large quantitative impact on inflation, especially over the next few years. Supply-side policies that create supply could also end up creating demand, and demand is currently way too high and needs to come down or inflation won't come down. For example, supply-side policies that bring more workers into the workforce, provide more child care, paid leave, and other investments in children would increase supply but could also increase demand because the size of labor supply would increase and people would be making more money. Furman isn't sure how this would impact inflation. 

The discussion then turned to what the Federal Reserve needs to do to get the economy around the two percent inflation target. Holtz-Eakin argued that the central bank needs to do what it says it's going to do. He noted that there hasn't been such a large gap between the inflation rate (the problem) and the real interest rate since the 1970s, and that crisis took nine years to resolve. Therefore, the Federal Reserve needs to close the gap between the real interest and the inflation rate as quickly as possible. Kelton, meanwhile, doesn't have faith in the capacity of the Federal Reserve to curb inflation by increasing or decreasing interest rates. She noted that our monetary policy tools work with long and variable lags, meaning we don't actually know when the impact of any interest rate changes will materialize. Moreover, it's quite possible that with the fiscal tightening that's already baked in, such as the roll off of fiscal support provided during the COVID-19 crisis, inflation may come down for other reasons. If inflation still remains high, we'll need to look at what's causing the inflation and make adjustments accordingly. If high inflation six months from now is all energy-related, decreasing interest rates may not be the best tool to combat it and other solutions will need to be pursued. 

Barro then asked the panelists what Congress and the Federal Reserve got wrong over the past year. Swagel noted that policymakers underestimated the strength of the economy at the beginning of 2021. The December 2020 COVID relief package extended unemployment benefits, issued another round of stimulus checks, and provided other fiscal support; and at the same time, the economy was already performing pretty strong. So fiscal policy was being implemented on top of a strong economy and monetary policy didn't adjust accordingly. Furman noted that the Federal Reserve spent most of 2021 saying it wasn't going to raise interest rates because it expected inflation to be lower. Normally, the Federal Reserve looks at inflation as transitory and assumes it's going to come down, but Furman no longer believes this is part of the Federal Reserve's narrative. Furman believes that the Federal Reserve really does mean it when it says it doesn't believe its models when it comes to inflation because of all the uncertainty in the economy and it actually needs to see the high inflation go away. The Federal Reserve isn't going to let up based on a favorable forecast like it did in 2021. 

The panelists were then asked what the appropriate fiscal response is if inflation and interest rates are still high in 2023. Kelton favors fiscal policy that builds capacity, while Furman noted that he's quite concerned about the debt ceiling and what will happen if it's not addressed properly. He also mentioned several action-forcing events coming up in the next few years: the expiration of the individual income tax provisions in the Tax Cuts and Jobs Act at the end of 2025, the insolvency of the Medicare Hospital Insurance trust fund in 2026, and the insolvency of the Social Security trust funds in 2034. Furman believes that if interest rates are still high and the national debt remains on an upward trajectory when these deadlines occur, action by Congress could be forced. Barro asked Furman specifically if the expiration of the TCJA's individual tax cuts in 2025 is the key to policymakers making necessary fiscal adjustments. Furman said yes, and cited the insolvency of the Social Security trust funds as another key moment to bring members of both parties together to make the necessary fiscal adjustments.

Barro then asked that as the free lunch era ends, should politics and the policies implemented revert back to the time when policy was driven by inflation and interest rates. And when there's an economic demand for budget deficits to be smaller, should Congress actually implement deficit-reducing legislation. Kelton believes the budget deficit is shrinking at the fastest clip we've seen and there's less reason to be concerned that Congress won't shift the balance toward tighter fiscal policy in response to changing economic conditions when that's precisely what's happening now. Holtz-Eakin believes Congress should do nothing in 2023 to manage inflation because it won't be able to get it right and instead should set a tax system and social safety net that fosters the greatest amount of economic growth. 

The discussion closed with the panelists offering their thoughts on student loans and the prospect of some kind of student debt cancellation. Kelton believes that the student loan payment pause will end on schedule (August 31) and there will be some sort of debt cancellation. To her, it's clear that any student debt cancellation proposals are being driven by politics, not economics. Furman believes that continuing the payment pause indefinitely would have the most significant impact on inflation; providing $10,000 per borrower of debt cancellation and ending the pause would have a medium affect on inflation; and resuming loan payments with no debt cancellation would have the smallest affect on inflation. Furman doesn't see any case for $10,000 of debt cancellation.