President Joe Biden takes office at a time of momentous opportunity. With vaccinations going and more money in Americans’ pockets, the US economy is ready to explode over the next few years, potentially boosted by productivity gains induced by the pandemic.
But America also faces significant challenges over the next decade, whether it be switch to renewable energies reduce carbon emissions, relaunch the manufacturing base, or face an increasingly aggressive China– and responding to them will probably require substantial public investment.
Billions of dollars in additional government spending will likely be required. And Congress and the Biden administration should do all they can to address these challenges, even if that means adding billions more to indebtedness of US $ 21 trillion.
Yes, those eager to oppose the new president’s agenda are right that the debt-to-national income ratio is already higher than at any time since World War II. But that’s not an argument against spending a lot more.
Instead, there are two compelling reasons for large-scale deficit-spending. First, market signals suggest that government borrowing has been far too low to meet the needs of the private sector for a long time, meaning that additional federal debt would be helpful to savers both at home and abroad. Current spending plans do not appear to change this basic reality. Second, investments that stimulate growth, whether in infrastructure, pollution control, scientific research, education or public health, pay off. A richer society can afford to take on more debt.
While the level of federal debt has climbed some $ 15 trillion since the end of 2008, Americans’ total debt didn’t, even with the pandemic. The increase in public borrowing was offset by a much larger economy and lower levels of private debt. So while the ratio of federal debt to gross domestic product rose from around 50% to over 100%, the private debt ratio rose from around 290% to around 240% over the same period. , leaving overall indebtedness roughly unchanged.
This is why the massive increase in the federal government’s debt did not coincide with an increase in interest rates. Instead, interest rates fell sharply because public loans were not enough to meet the income and savings needs of households and businesses.
If the government spent too much money in the economy compared to what it took in taxes, the difference would translate into huge price increases for consumer goods and services. This has not happened so far, and in fact Federal Reserve officials were frustrated for years by below target inflation.
Likewise, if the Biden administration’s borrowing and spending plans were excessive, the prices of inflation-sensitive assets would adjust in anticipation. But savvy investors don’t seem worried about inflation at all, even though they’re less concerned about deflation than they were in March.
The prices of most commodities, including copper, silver, petroleum, wheat and cotton, remain well below those of a decade ago.
And the prices of inflation options only involve a one in five chance that the consumer price index will increase by more than 3% each year over the next five years, on average, and only 10% chance that prices will increase by more than 3.4% each year. These implied odds are much lower than the implied odds for 2012, and about the same as in 2017-18.
Persistent low inflation explains why the Fed and other central banks around the world have felt compelled to cut interest rates since the late 1980s in an attempt to fuel private borrowing and spending. This explains why the federal government spends much less on debt service today than it was 30 years ago, even though the level of debt is much higher now. All of this suggests that there are plenty of opportunities to borrow and spend more money without hurting the economy.
In addition to all this, borrowing and spending on the right things should also increase the productive capacity of the economy, which would improve everyone’s situation and further reduce the risk of consumer prices rising excessively.
Consider that in August 2007, just before the global financial crisis,economists at the Congressional Budget Office expects the US economy to grow sustainably at around 2.6% per year, at least until the end of 2017. If this had happened, the US economy would have been 12% larger than it was before. This gap represents a huge loss of income and wealth.
Rather than acknowledging the magnitude of the financial crisis, the CBO concluded that its pre-crisis forecast was just too optimistic. For nearly a decade, the CBO continuously lowered its estimate of the potential of the U.S. economy, until the Trump administration and Congress ignored the estimates and decided to cut taxes and increase spending.
The resulting surge in investment was modest, but it was enough that, on the eve of the pandemic, the CBO concluded that the United States had more room for growth than it had previously believed. The acceleration of the economy reduced the total indebtedness of the United States from late 2016 to late 2019, even as the federal budget deficit grew.
Already, the CBO is predicting a permanent loss of income due to the coronavirus. It would be a disaster, but the bottom line for the new administration is that it can be avoided with enough money and focus now.
Write to Matthew C. Klein at [email protected]