Families Don't Need to Balance Their Budgets Every Month — and Neither Should the U.S.

It’s true that America is broke. If you compare the country’s current budget situation to that of an ordinary American household’s, the country should have long ago declared bankruptcy. America simply is not able to repay all of its outstanding debt without seriously jeopardizing its economic and social stability.

Some politicians have used that analogy to highlight the severity of the country’s current fiscal situation. However, it doesn’t require sophisticated knowledge of fiscal policy to realize it might be specious. American households routinely take out mortgages that are more than 100% of their annual income. In comparison, the net national debt held by the public is about 71% of GDP. Using the logic of the aforementioned argument, an overwhelming majority of American households are even more financially irresponsible that the federal government. Current public debt is far below the 120% of GDP levels it reached during the post-WWII era when the United States solidified its economic dominance. Although serious discussion needs to be had on the country’s long-term debt situation, there is little evidence to suggest current short-term spending intended to address the effects of the financial crisis poses a catastrophic risk to the economy. I would therefore like to pose a slight revision to the public debt analogy, and urge policymakers and the public at large to view certain aspects of current spending the same way prospective homeowners do — as an investment in their future.

The recent asset collapse was the worst since the Great Depression, with contractions in global industrial output, stock markets, and world trade roughly a year after its start that were actually more sudden and severe than those of the entire Great Depression era. The modern prescription for this type of asset collapse entails increasing the money supply, lowering the real interest rate, stimulating demand, recapitalizing the banking system, and the use of fiscal policy in the short run to support growth. This remedy has been endorsed by economists from both major parties, and used by both Democratic and Republican presidents. In fact, current Federal Reserve chairman, and George W. Bush appointee, Ben Bernanke has been a strong advocate of this policy. The basic logic behind the practice is to use strong government intervention to help break the economic deadlock by creating demand for consumer goods, inducing investments to get the economy going again. President Herbert Hoover’s administration allowed the money supply to collapse following the crash of 1929, with then-Treasury Secretary Andrew Mellon strongly opposed to government bailouts that would prevent the natural restructuring he believed was needed. Bernanke, who is a leading expert on the Great Depression, was determined to not see a repeat of these policies. The claim that the stimulus hasn’t worked because of subsequent weak economic performance is attributed to its relatively small size compared to GDP by some economists such as Bob Hall of Stanford.

 

Stimulus critics also claim government spending crowds out more productive private investment, but as Carnegie Mellon University economist and former member of President Obama’s Council of Economic Advisors Lee Branstetter notes, these criticisms tend to rely on appeals to basic American values instead of actual economic models. The graph above, created by Hall, shows that stimulus spending actually coincided with an increase in private investment. Dr. Branstetter notes one telltale sign that government spending is crowding out public investment is high interest rates given finite investment capital. In comparison with 10-year bond yields during Reagan’s administration, where large peacetime deficits might have crowded out private investment by bidding up the price of capital, current interest rates are some of the lowest in a generation. Reduction in confidence in the American economy has also been attributed to increasing federal debt, but the relative cost of U.S. debt-default insurance is lower than China's, Germany's, and the U.K.’s. The U.S. is also able to borrow money at a negative real interest rate in the short term and at some of the lowest rates in a generation in the long term.

Although the market says we face no long-term financial crisis, the country’s aging population and rising entitlement costs for the numerous Baby Boomers who will soon draw down their benefits will still require a long-term fiscal solution. The remedy for these long-term fiscal issues will most likely require reductions in spending and health care costs in addition to tax increases. However, as Fed Chairman Bernanke warns, tax raises and spending cuts are not yet needed and would actually have negative effects on the nation’s economic recovery. Much of the anti-government-spending rhetoric isn’t substantiated by market data. Targeted government investments in human capital and infrastructure will allow the nation to take advantage of the current global economic trends benefiting highly skilled service providers. Short-term investments in the country’s economic recovery will allow time to address long term deficit issues by facilitating our competitiveness in the short term.

 

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