Does the U.S., in the short term, have a debt problem or a growth problem?

Image Credit: MKM Partners

Image Credit: MKM Partners

In a new note, MKM Partners economist Michael Darda highlights the relationship (as displayed in the above chart) between nominal GDP on one hand, and economic growth (and unemployment) on the other):

The U.S. fiscal deficit, while large, has been tracking the gap between U.S. output and its trend (or potential). In other words, “It’s the NGDP, stupid.” When U.S. NGDP plunged 8% below trend in 2009, deficits mushroomed to 10.4% of GDP as tax revenues fell and automatic stabilizers and other rescue programs kicked in.

As output and employment have begun to recover, however, deficits have eased from just more than 10% of GDP in 2009 to about 7% of GDP in 2012. If current trends continue, annual deficits would fall to about 3% of GDP in just more than three years, about the same time we may expect the unemployment rate to return to a normal level (5%-6%).

Ultimately, demographic pressures (mainly per-capita health care spending) will push deficits back up to unsustainable levels, but this doesn’t have much bearing on recent deficit trends, which are largely, if not wholly, cyclical.

Of course, to the extent policy uncertainty has retarded growth, that’s been a problem, too. There is also the opportunity cost of not pursuing pro-growth tax reform and entitlement reform. And I do think the debt is a near-term issue since it may already be slowing growth and puts the U.S. in a precarious position if we should suffer another financial crisis anytime soon. But Darda is mostly right on the causality direction.

Anyway, he also makes a good point about how the U.S. should escape its debt trap and close the growth gap in a potentially bipartisan way:

In our view, the best way to deal with both cyclical and structural deficits would be to combine a NGDP level path target from the Fed with long-term structural reforms to entitlements and the tax code (along the lines of Simpson-Bowles or Domenici-Rivlin). This would also help to limit the effect on incentives from raising the revenue share
of GDP to more adequate levels.


4 thoughts on “Does the U.S., in the short term, have a debt problem or a growth problem?

  1. Neither. The U.S. has a liberty problem. It has led to a debt and regulation problem. The goal should not be to restore “growth” to bail out debt and the politicians’ lifestyles. The goal should be to restore liberty to bail out lack of liberty.

  2. First of all the sum of the unfunded liabilities plus total federal, state, corporate, and household debt stands at more than $100 trillion in a $16 trillion economy. Approximately half of the tax revenues that are collected go out to pay for the Pentagon, the off budget war expenditures, CIA, foreign aid, VA, interest on accumulated war debt, NASA military programs, NSA, DHS, and other military related issues. At the same time you have a massive problem with SS and Medicare funding as there is nothing in the trust funds and monthly outflows grow to be greater than monthly revenues.

    The way I see it the most reasonable approach is default. Let the bond markets fail by refusing to honour debts. Without the ability to borrow governments would have to live within their means and would have to show taxpayers the true costs of the programs that they are supporting. Go back on a hard money standard and allow private institutions to compete with the Federal Reserve in the field of money creation. While there would be a major collapse the recovery would be swift once the bloated government programs and unnecessary regulations find their way into the dustbin of history.

    Of course, you could also try legalizing drugs and using the tax revenues to fund some of the bloated programs that are threatening the country. That is what happened in the 1930s when the end of Prohibition put an end to the property tax riots. Combine that with the end to all of the unnecessary wars and you will have more revenue and less expenditures. That would allow the day of reckoning to be postponed for another decade or so.

  3. The Fed is printing money, in QE3 to date, but no where near what would be necessary for a true policy of tracking NDGP. It is attractive because it shifts part of the burden to foreign investors who hold US debt for safety or currency considerations. It seems to me, though, that it would pouring gasoline on that uncertainty thing unless Congress shows some signs of valuing country over party.

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