Fed Chair Warns of Risk in High Deficits

Blog Post
Friday, October 05, 2018

With the federal deficit projected to exceed $1 trillion in Fiscal 2020, many economists worry that Washington’s heavy borrowing to cut taxes and increase spending could make it more difficult to counteract the next economic downturn.

At an event this week, Federal Reserve Chairman Jerome H. Powell agreed that this is a valid concern: “These last innovations in fiscal policy, at least in the medium term, have probably reduced the amount of fiscal space that we have to react.”

He offered that caution in response to a moderator’s question about whether there was reason to worry about the rising federal deficit despite strong economic growth this year. (Ideally, the government should take advantage of a strong economy -- with a healthy flow of tax revenue and less pressure on safety-net programs -- to reduce deficits.)

The Wall Street Journal, which reported Powell’s comments at the annual meeting of the National Association for Business Economics (NABE) in Boston, called them “the closest thing to a critique of Trump-era fiscal policy that Mr. Powell has offered since he took office in February.”

At the top of the economic cycle, Powell said, “it’s a good time to be working on putting our fiscal house in order.” This would create the “fiscal space” for the government to borrow money to combat a recession.

Powell has said previously that the tax cuts approved last December would likely give a temporary boost to U.S. economic demand. However, he said in Boston that “we’ll have to see” whether the cuts increase the economy’s productive capacity, as the president and many in his party predict.

On the subject of deficit reduction, Powell was preaching to the choir at the NABE meeting.

In late August the association reported that large majorities of business economists said in a survey that current U.S. fiscal policy has been over-stimulating the economy and should be aimed at reducing the federal deficit rather than increasing it.

The organization said 81 percent of the survey respondents thought fiscal policy “should reduce the federal deficit’s share of GDP when compared with the Congressional Budget Office’s (CBO’s) baseline.”

Most of the economists, however, were not optimistic that this advice would be followed. In the survey 83 percent of the respondents thought the most probable tax and spending policies would further increase the deficit.

Unfortunately, that could well be the case. But elected officials would do well to heed Powell’s suggestion that they view today’s strong economy as an opportunity to better prepare for more difficult circumstances.