Last week, Nouriel Roubini published a characteristically sobering op-ed in the Financial Times that drew attention to an issue of great interest to my colleagues at Economics 21, namely the problem posed by the U.S. government’s hidden liabilities:
The bond vigilantes are asleep, while borrowing rates remain unusually low. Near zero rates will continue as long as growth and inflation are low (and getting lower) and repeated bouts of global risk aversion – as with this spring’s Greek crisis – will push more investors to safe dollars and US debt. China’s massive interventions to stop renminbi appreciation will mean purchasing yet more treasuries too. In short, kicking the can down the road will be the political path of least resistance.
The risk, however, is that something on the fiscal side will snap, and the bond vigilantes will wake up. The trigger could be a debt rollover crisis in a major US state government, or perhaps even the realisation that congressional gridlock means bipartisan solutions to our medium-term fiscal crisis is mission impossible. Only then will our politicians suddenly remember that, on top of our federal debt, the US suffers from unfunded social security and Medicare liabilities, state and local government debt, and public pension bills that add up to many multiples of US GDP. [Emphasis added.]
Roubini doesn’t mention GSE debt, but that could easily be added to the list.
Recently, a blogger suggested that I care about transparency because I want the new health law look worse than it really is, and the idea depressed me. That couldn’t be further from the truth. I favor transparency because it gives policymakers a clearer picture of the world we live in, and a better shot at avoiding truly terrible outcomes. This is why I also favor more public investment in building better climate models. The case for fiscal consolidation is, in my view, very similar to the case for taking action against the relentless global increase in carbon emissions. Whatever you think of the likelihood of an extreme outcome, we want to preserve our options to the extent possible. A cautious embrace of fiscal consolidation, like what we’ve seen in Britain, gives us more options if the global economic environment takes a turn for the worse, e.g., if turmoil in the Gulf region wreaks havoc in oil-dependent regions (i.e., all regions).
There are, of course, other reasons, but this seems like an important one to keep in mind.
All that said, I am sympathetic to Roubini’s view that a too-quick turn to fiscal consolidation should be avoided. Britain, for example, has had robust growth recently, and it has a higher inflation rate than the U.S. The risk of deflation in the U.S. is not as pronounced as it is in the U.S.
The Obama administration did the right thing early, and avoided another depression. He is still doing the right thing now in pointing out the risks of early austerity. And he is limited by an unco-operative Republican party trapped in a belief in voodoo economics, the economic equivalent of creationism. Even so, he and his party have been unwilling to tackle long-term entitlement spending. Two years in, and this means the US remains on an unsustainable fiscal course.
I am more sympathetic than I have been to renewed fiscal stimulus in the form of a deep payroll tax cut, as recommended by Larry Lindsey last year [PDF] and Gov. Mitch Daniels more recently. I’d just want to be sure that this payroll tax cut was coupled with credible entitlement reform, which is much easier said than done.