If You Think Snowmageddon is Bad, Blizzard of Debt Will be Worse

Feb 10, 2010 | Economics

Experts concerned about the nation’s fiscal and economic outlook braved the snow yesterday to participate in a Senate Budget Committee hearing on “Crisis and Aftermath: The Economic Outlook and Risks for the Federal Budget and Debt.” There was a great deal of agreement among the economists testifying that confronting the debt would be critical to promoting economic recovery and growth. As Washington digs out of 2-plus feet of snow, we must stop digging a larger debt hole.

Carmen Reinhart of the University of Maryland said that her research of financial crises in 44 countries over two centuries shows that high debt levels (90% of GDP or more) result in lower growth. Median growth rates fall one percent when debt is above 90% of GDP.

She also noted that countries seldom grow their way out of deep debt burdens. While she does not recommend that the U.S. back out of stimulus now, she indicated that developing a credible exit plan now to be implemented later would lower the risks of paralyzing debt problems down the road. “Countries that have not laid the groundwork for adjustment will regret it.”

Donald Marron of the Georgetown Public Policy Institute seconded much of what Reinhart said. He testified that the U.S. is on an unsustainable fiscal path and that persistent deficits and rising debt pose a serious risk to the American economy and global leadership position. According to Marron, policymakers must delicately balance addressing the looming fiscal crisis while encouraging the fragile economic recovery.

He advises that, while serious steps to address debt not be taken this year or next, that “Congress should begin to plan now for deficit reduction and debt stabilization in later years.” Such a plan must include clear goals, such as a target for the debt-to-GDP ratio. He specifically mentioned the goal recommended by the Peterson-Pew Commission on Budget Reform in the Red Ink Rising report of aiming for a 60 percent debt-to-GDP ratio by 2018, although he suggested that 2020 was a more realistic target date.

He stated that a credible plan would keep interest rates low and strengthen the current recovery; arguing that world financial markets would reward the U.S. for addressing its fiscal challenges with lower interest rates. He also noted recent research suggesting that economic stimulus is more effective when paired with a credible fiscal plan.

Simon Johnson of MIT echoed the calls for deficit control. He cautioned that the sovereign debt crisis affecting some European countries could spread, straining already weak U.S. banks. This would cause credit conditions to tighten even more. He concluded his opening statement with an ominous warning, “We are steadily becoming more vulnerable to economic disaster on an epic scale.”

Johnson and Marron agreed on the need for a fiscal commission. And all agreed that spending and revenues had to be considered in addressing the debt.

The recent warning from Moody’s that the Triple A bond rating for the U.S. is in jeopardy absent measures to stabilize the debt relative to the economy underscores the need for a fiscal plan with real goals. The committee will hold another hearing tomorrow to examine appropriate fiscal targets. CRFB president Maya MacGuineas will be joined by board members Alice Rivlin and Rudolph Penner at the witness table.

The Peterson-Pew Commission will convene a forum on Tuesday, February 16 in Washington, DC that will address how the U.S. can avoid a debt crisis. Speakers will include former comptroller general of the U.S. David Walker and Federal Reserve Bank of Kansas City president Thomas Hoenig.