Reconciling Fiscal Stimulus and the Deficit

Blog Post
Monday, October 20, 2008

Our Executive Director, Bob Bixby, recently participated in an online discussion on the "National Journal's Expert Blogs" focused on whether there is room for fiscal stimulus in the budget, given the extraordinary change in the fiscal position of the government due to the economic downturn and the government's already unprecedented response. Here is his post:

"Yes, there is room for fiscal stimulus -- so long as it sticks to the principles of being timely, targeted and temporary. What we don’t have room for are permanent new policies, either on the spending or tax side, that aren’t paid for. While the very real threat of a serious and lengthy recession justifies deficit-financed stimulus in the near-term, we need to keep in mind that our underlying fiscal policy is already on an unsustainable track. Treating the short-term problem should do as little harm as possible to the long-term outlook. Economically speaking, we need to walk and chew gum at the same time.

The goal of additional fiscal stimulus is to boost consumption and avoid a deep recession. Since we are already running a deficit, fiscal stimulus would increase the government’s debt and decrease national saving. The immediate effect would thus run counter to the longer-term goal of promoting economic growth through more adequate saving and investment. We can’t borrow our way to sustainable prosperity any more than the housing bubble could sustain itself on perpetually growing debt. To get the U.S. economy back on a sustainable path, not just over the next few days, weeks, or months, but over the next several years, the U.S. needs to save more. Budget deficits subtract from savings, so deficit spending now is tolerable only if it does not jeopardize that longer-run goal.

It is critical that the next president set clear priorities and be willing to make tradeoffs, so that the policies pursued over the next several years get us back on the path of higher national saving and a stronger economy. We can’t afford to focus only on the present. Beyond the current crisis in the financial sector looms the growing cost of Medicare and Social Security. Contrary to Professor Galbraith’s assertion, the deficits projected under current law, and their adverse affect on savings, investment and economic growth, are no mere “figment of the imagination.” Call it a fiscal crisis or a health care crisis, the bottom line is the same: current spending promises cannot be financed at today’s level of taxation. No amount of fiscal stimulus will change that because it is a structural, not a cyclical, problem. We cannot assume a perpetual inflow of cheap foreign capital to finance our standard of living, nor should we want to. Eventually, we will find ourselves paying higher interest rates to attract such capital and the resulting mortgage on future national incomes will diminish our standard of living.

That is why the best policy response is to combine short-term stimulus with long-term discipline. There is nothing inconsistent in this. If properly designed, fiscal stimulus will not have an adverse impact on the long-term, and long-term discipline will not have an adverse impact on the short-term. We don’t need to sacrifice one to achieve the other, and we need to be clear about the trade-offs--starting now."

--Josh Gordon