Peterson Report Calls for Fiscal Balancing Act
In the context of a middling U.S. economic recovery, several commentators have argued that we should ignore deficit reduction in order to pursue growth-promoting policies. This debate, however, overlooks a critical point since both objectives can be achieved simultaneously. A recent report commissioned by the Peter G. Peterson Foundation, authored by economists Janice Eberly and Phillip Swagel, highlights just this point, that economic and fiscal health are not in conflict.
The report, “Fiscal Balancing Act,” gives an overview of U.S. fiscal trends and challenges and puts forward several guiding principles for debt and deficit reduction. A key message of the report is that a gradual, well-targeted deficit reduction strategy is not only important for fiscal sustainability, but also for growth, productivity, and mobility.
As the report highlights, timing is critical when it comes to deficit reduction. When the economy is weak, abrupt near-term deficit reduction can undermine economic growth, making it more difficult to get finances in order. The report states that this type of fiscal retrenchment should be avoided until the U.S. recovery has gained further momentum and until monetary policy has the space to be more accommodating (when interest rates move away from the zero lower bound).
Of course, this isn’t an excuse for policymakers to abandon fiscal discipline. As the report makes clear, our long-term fiscal position is unsustainable. Not only is population aging set to drive up long term health and entitlement costs, but it will also hold down productivity growth and labor force participation, slowing the growth of potential GDP and reducing the capacity of our economy to sustain higher debt and deficits. The long-term concern for this run-up in debt is the impact on growth and our ability to use fiscal policy as a countercyclical tool. As the report says:
With long-term borrowing rates still low, the concern is not over immediate crowding out in which government borrowing deters private sector activities such as business investment. The potential danger instead is from the loss of fiscal room to maneuver in the future – a situation in which private sector concerns over sustainability make it costly to undertake a debt-financed fiscal expansion in the face of a cyclical downturn.
Although the concern about high debt is a longer-term one, being proactive has many benefits. Enacting a plan now that takes effect gradually would give markets confidence in our capacity to pay down debt over the long-term, helping the short-term economy. In addition, being proactive allows the federal government to maintain fiscal space, which may not be the case if lawmakers delay action.
Just as the timing of deficit reduction is critical, composition also matters. The report argues that savings should not just be seen as a counting exercise; instead; lawmakers should keep an eye toward promoting growth and social mobility. This means making room for productivity-enhancing investments – such as investments in infrastructure, education and research and development – and protecting society's most vulnerable. A comprehensive debt reduction strategy, including reforms to heath care programs, retirement programs and the tax code, would create room for these priorities.
Of course, the deficit reduction enacted in recent years has largely done just the opposite. Lawmakers have focused on the areas of the budget that include most of our investments and which aren't the drivers of long-term debt, meaning the long-term issue remains. Instead, a comprehensive strategy that reduces our long-term debt can better balance the economic needs of the country and put both our budget and economy on a stronger path.