By Howard Schneider
DENVER (Reuters) – Economists are divided about when the next U.S. recession will arrive, but they largely agree on this: the country will need to fight it with a massive fiscal programme, and be ready to swallow deficits that may eclipse the trillion-dollar shortfall run by the Trump administration this year.
Past discussion has focused on the Federal Reserve as the more powerful first responder, and how rising U.S. debt carries its own risks. Now talks are about how much money ought to be spent and where it should go – whether to infrastructure, programs to counter climate change or direct payments to households.
In the next recession, the United States should contemplate “a pretty generous package,” of perhaps as much as $1.7 trillion, double the amount approved for recession fighting in early 2009 during a steep downturn, Karen Dynan, a former Fed and Treasury official now at the Peterson Institute for International Economics, said in a recent discussion of the world economic outlook.
“We do have fiscal space,” she said.
This pro-debt attitude finds broad agreement among corporate economists, academics, think tank analysts, and private forecasters alike, and not just in the United States.
Japan, with debt twice the size of its economy, has had no trouble issuing more. While Japan’s situation is unique in some ways, even Europe’s more debt-wary nations may be opening to the idea that there are good reasons to borrow, particularly to meet emerging commitments to reduce reliance on carbon-based fuels, said Jean Pisani-Ferry, a senior fellow at Bruegel, a European think tank.
Fighting climate change “may be an excuse for fiscal action” in countries that would be wary of spending just to boost short-term consumption, he said.
The shift in tone on government debt comes as Europe is facing a possible recession, China’s economy has ebbed, and concern is rising about a possible U.S. slowdown. An ongoing U.S.-China trade war, meanwhile, may lead to a long and costly adjustment to a less globalised system.
The consensus that major world governments can borrow more is driven by a simple fact: over a period of time when the United States was running up a trillion dollar deficit, the Fed was tightening policy and the U.S. economy was growing faster than expected, interest rates on U.S. Treasury bonds remained low – and even notched some new records.
That has led to a broader rethink about how much debt countries like the United States can safely take on, particularly now that long-term trends such as population ageing are thought to be a permanent anchor on interest rates. Since older people save more and are more averse to debt, the argument goes, the supply of global savings will rise and demand for credit will drop, thus lowering the cost of borrowing.
Couple that with tepid inflation – and the fact that trillions of dollars in central bank bondbuying in recent years failed to generate much of it – and there seems little reason to think the United States is facing any imminent “fiscal cliff.”
“This is the demographic point. We are going to be close to the zero lower bound (on interest rates) forever,” a fact which gives central banks less room to boost the economy through traditional rate cuts, but also gives more room for government to borrow, said Julia Coronado, a former Fed staffer and founder of Macropolicy Perspectives consultants.
U.S. debt in relation to the size of the economy “is going up no matter what…You can see politically it is going to happen,” she said, with no strong constituency in either major party arguing for aggressive short-term spending control. When the United States saw its spotless credit rating downgraded amid a political impasse on the debt ceiling in 2011, and interest rates still fell, “a bunch of light bulbs went off in a bunch of politicians’ heads…It is like magic money.”
Coronado spoke at a seminar at the recent conference of the National Association for Business Economics devoted to Modern Monetary Theory, a set of ideas that would pave the way for the United States to issue vastly larger amounts of debt.
MMT has figured into plans developed by some Democratic presidential candidates for guaranteed employment programs, as well as massive proposed expenditures to combat climate change.
But even among mainstream economists, rising debt – at least for nations with strong currencies and institutions – is no longer a dirty word. With the influence of the Fed and other central banks seeming to wane, policy analysts are looking at other ways to respond to economic stagnation, such as the expansive use of automatic programs that would start sending checks to households as soon as a recession starts.
Coronado spoke alongside Catherine Mann, global chief economist at Citi, and Laurence Meyer, a former Fed governor known as an inflation hawk in the 1990s. All agreed the United States had more room to borrow, even though the ratio of publicly held debt to gross domestic product, currently around 76%, is expected to rise steadily past the 90-100% levels some economists have set as a benchmark for trouble.
“We don’t know how much fiscal space there is. There is clearly more,” said Meyer. “We do have opportunities, and there are unmet social needs.”
Over the past year in particular the benchmarks once seen as near inviolable have been considered less and less binding, particularly for the United States. The country’s role as issuer of the world’s reserve currency, and image as a safe and stable place to do business, keeps demand for U.S. debt high and its interest rates low in a world hungry for a “risk-free” way to invest.
Prominent mainstream figures like former International Monetary Fund chief economist Olivier Blanchard have argued that large, stable governments should not be reluctant to borrow for socially or economically beneficial projects as long as interest rates remain, as they are now, below the economy’s rate of growth.
Mann said that while there may be limits – and that the dollar’s privileged standing should not be taken for granted – the more important debate now is less about how much debt is issued than how it is used.
“It is entirely ‘what are you going to do?’” she said. “Tax cuts or spending? What are the multipliers? You can waste money and it will have been a bad thing. Or you can use it for something effective that enhances the economy’s capacity to grow and improves distribution.”
(Reporting by Howard Schneider; Editing by Andrea Ricci)