Over at Slow Boring, Matt Yglesias has a good piece asking where the deficit hawks have gone.
Ten years ago, the United States was in the grips of a broad obsession with the federal budget deficit. . . . Weirdly, though, here we are in 2022 with unemployment low, inflation high, and interest rates rising fast, and nobody is talking about this anymore.
He points to a new paper by the CRFB, called “Fiscal Policy in a Time of High Inflation,” as the sole representative of those who care about our current predicament, which makes me think that he’s exclusively addressing his friends on the left. Many non-left (for lack of a better word) scholars have been very active on this issue.
The first who comes to mind, of course, is the Hoover Institution’s John Cochrane. He has long been beating the drum regarding the fact that inflation lives in the shadow of the debt. This is just one of his more recent columns but you can find many more on his blog: the Grumpy Economist. Brian Riedl wrote a superb study, before the pandemic, on the fiscal impact of higher interest rates. Similarly, Jack Salmon and I have published a few papers on this issue starting last year, including one called “Inflation in Times of High Debt.”
I understand why Yglesias may not think it’s a big deal when fiscal conservatives are alerting the world of the risks associated with high debt during inflation. It’s the equivalent of my finding it a big deal when he writes this:
A decade ago when deficit reduction didn’t make a lot of sense, everyone and his mother was producing deficit reduction plans, and mainstream economic policy coverage would’ve been all over something like a fresh CRFB report. So I’m going to be the change: this would be a good time for deficit reduction.
But he’s right. No matter where one stood on the issue of deficit reduction prior to 2021, it is an issue that nobody should ignore in 2022.
It boils down to this. When inflation is as high as it is today and the main way to control it is by the Fed’s raising interest rates, a few fiscal facts become salient: The federal debt is 100 percent of GDP and rising (as a reminder, the debt-to-GDP was 25 percent in the 80s), and the Fed and the Treasury fund the debt by rolling over short-term bonds. 30 percent of our debt has a maturity of one year while most of our debt has a maturity of three years of less.
Combine a debt of 100 percent of debt of GDP with lots of short-term debt — and with the need to raise interest rates to tame inflation — and the result is explosive on interest payments, the federal budget, and deficits. The rise in interest payments has already started and it will only intensify in 2023. So will deficits. How much? A lot:
Using the Congressional Budget Office interactive budget tool, we can get some idea of the scale of the additional debt-servicing costs caused by higher than anticipated interest rates. If the interest rate on the 10-year Treasury note is 0.5 percentage points higher than expected in the coming decade, the cumulative budget deficit during the same period will be $1.43 trillion larger than the baseline projects. If the interest rate is 1 percentage point higher than expected, the cumulative deficit will be $2.85 trillion larger over the decade.
So, when Yglesias asks “where have all the deficit hawks gone?” I reply: “They’re coming.”
Without intending to get too in-the-weeds of this debate: If Congress and the administration don’t cut spending to accommodate the increase in interest payments, they’ll be throwing more oil on the inflation fire. (You can imagine how the administration’s additional spending on student-loan forgiveness isn’t helping, either.)
The good news is that we know what to do. Yglesias does hint at another solution in addition to Fed actions: He calls it fiscal policy. I call it fiscal consolidation. But we are mostly talking about the same thing. The better news is that enough of us at this point realize that we are in a different situation than the ones we have been in before, that we could put our differences aside and work together, and find a bipartisan fiscal solution to help deal with inflation.
If that is paired with some growth-oriented microeconomic reforms, like NEPA, or land-use and zoning reforms, you can boost growth the right way (the supply-side way). I don’t want to oversell supply-side reforms in the fight against inflation, as they can potentially affect expected inflation, but they mostly affect relative prices, not overall inflation. But it is true that better and growing supply means more output and more revenue for the government. That’s really the best mechanism for sustained growth and deficit reduction in the decade to come, which will in turn help us slowly pay back some of the debt.