The Agenda

Simon Johnson on the Medium-Term Prospects of the U.S. vs. Europe

I recommend taking a look at Johnson’s new Economix post contrasting the risks surrounding the fiscal position of the United States and the eurozone economies over the next decade:

Either Europe really ends moral hazard and widely restructures sovereign debts, or it keeps the bailouts coming, with the deep involvement of the European Central Bank, which will ultimately be inflationary. The package announced last week is a classic case of muddling through; it doesn’t really solve anything. (See the Economix Q. & A. on Greece’s latest debt deal.)

If Europe and the world now experience a growth miracle, these debt problems will recede in importance, because solvency is all about debt burdens relative to G.D.P. But if near-term growth is not strong, as seems increasingly likely, market participants will soon resume their contemplation of European dominoes.

In contrast, the United States has a simple fiscal problem – as I discussed inmy testimony to the House Ways and Means Committee this week. Government debt surged from 2008, not because of Greek-style profligacy but rather because of an Irish-style banking disaster. When credit collapses, so does revenue. As the economy recovers, revenue comes back.

As Johnson goes on to note, however, the fiscal position of the U.S. will deteriorate markedly after 2021, and Johnson, not surprisingly, doesn’t believe that the American center-right will address the real source of the debt explosion:

The debate in Washington is both heated and off course, because no one is grappling with the difficult issue of how to control health-care costs. The Tea Party enthusiasts are intent on near-term government spending cuts as a condition of supporting any increase in the debt ceiling.

If this version of a libertarian tax revolt carries the day, the resulting fiscal contraction will slow the economy and fewer jobs will be created. It does nothing directly to address the looming budget issues beyond 2021.

It is safe to assume that Johnson doesn’t consider Chairman Ryan’s Medicare reform proposal a sufficiently serious effort, perhaps because it is widely considered politically unpalatable. I continue to think that something like the Ryan approach, based around limited defined contributions, is the right way to fix Medicare and the broader health safety net, though I imagine that a durable settlement would look much more like Domenici-Rivlin. 

Has the debt ceiling debate raised the likelihood that we will see something like a Domenici-Rivlin settlement? It’s not clear to me that this is true. 

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