A Fine Fiscal Balance
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Policy Finance & Accounting Jul 7, 2014

A Fine Fis­cal Balance

A con­ver­sa­tion with Jan Eber­ly on sus­tain­able fis­cal policy.

Yevgenia Nayberg​

Jan Eber­ly served as Assis­tant Sec­re­tary for Eco­nom­ic Pol­i­cy at the Trea­sury Depart­ment from 2011 – 2013, for a Demo­c­ra­t­ic admin­is­tra­tion. Her col­lab­o­ra­tor on a recent arti­cle, Phillip Swagel, held the same posi­tion in the pre­vi­ous Repub­li­can admin­is­tra­tion. The pair recent­ly gen­er­at­ed a series of fis­cal pol­i­cy rec­om­men­da­tions in a recent arti­cle for the Peter G. Peter­son Foun­da­tion. Eber­ly was kind enough to speak to us about those recommendations.

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Kel­logg Insight: What made the two of you sit down togeth­er to do this?

Eber­ly: There’s a per­cep­tion, as peo­ple watch pol­i­cy being made in the polit­i­cal are­na, that there’s a broad gap between dif­fer­ent points of view — espe­cial­ly on fis­cal issues, where con­tro­ver­sy has result­ed in the gov­ern­ment shut­down and the debt-ceil­ing debate.

But among econ­o­mists who work on fis­cal pol­i­cy, there’s actu­al­ly quite a lot of con­sen­sus on big issues. Of course, there’s dis­agree­ment on exact­ly what should be done and how, but Phill and I actu­al­ly have very sim­i­lar points of view on what the broad strokes of fis­cal pol­i­cy need to be going forward.

KI: Thanks to seques­tra­tion cuts and oth­er pol­i­cy changes, low bor­row­ing rates, and our emerg­ing recov­ery, the bud­get is actu­al­ly in a pret­ty okay place right now. Is that right?

There’s a lot of con­tro­ver­sy about whether there’s some thresh­old num­ber after which the debt-to-GDP ratio real­ly becomes a problem.

Eber­ly: It has improved sub­stan­tial­ly. In the depths of the finan­cial cri­sis and the reces­sion, the bud­get deficit was around 10% of GDP. As the econ­o­my has recov­ered, rev­enue has got­ten stronger. Sup­port for reces­sion-dri­ven pro­grams has been pulled back, and so the bud­get deficit has nat­u­ral­ly tend­ed to close. Then on top of that, explic­it pol­i­cy mea­sures have been put in place and have also helped.

The bud­get deficit in the most recent data is run­ning a lit­tle under 3% of GDP — below the long-run aver­age. That takes off the imme­di­ate pres­sure. But we have long-term chal­lenges, and these will be eas­i­er to address if we do so at a time like now, when we’re not in a reac­tive sit­u­a­tion, and can make delib­er­ate and thought­ful pol­i­cy decisions.

KI: So we have about a decade, you esti­mate, before our debt will start to become unmanageable?

Eber­ly: There’s a lot of con­tro­ver­sy about whether there’s some thresh­old num­ber after which the debt-to-GDP ratio real­ly becomes a prob­lem. I think the con­sen­sus among econ­o­mists is that the debt-to-GDP ratio can’t be looked at in iso­la­tion. There’s also a country’s abil­i­ty to col­lect tax­es, its cred­it pol­i­cy, whether cred­it is grow­ing quick­ly, and the strength of its polit­i­cal insti­tu­tions. So it’s not as if there’s a moment we can point to in the future and say, That&rsqursquo;s the deadline.”

We do know that, with cur­rent poli­cies in place, the debt-to-GDP ratio is pro­ject­ed to even­tu­al­ly grow unsus­tain­ably. We know that action needs to be tak­en, and the soon­er we do it, the less dra­mat­ic it will have to be.

At the same time, the econ­o­my is still get­ting back on its feet. The data last week showed that GDP shrank in the first quar­ter. There were some one-off fac­tors, like the weath­er, that help explain why the num­bers look so grim, but it’s a reminder that the econ­o­my is still recov­er­ing. On the oth­er hand, employ­ment has been improv­ing. So, we want to be cau­tious about what addi­tion­al shocks we inter­ject into the economy.

KI: You rec­om­mend two fronts for long-term fis­cal action. What are these?

Eber­ly: The first is to expand the focus of our bud­get delib­er­a­tions. Fis­cal adjust­ment, large­ly through the sequester, has thus far focused on the dis­cre­tionary spend­ing part of the bud­get. But this is just one part of the bud­get, and a nar­row one at that. Even with­in spend­ing, it excludes all of the manda­to­ry pro­grams” fund­ed by the gov­ern­ment and Con­gress: leg­is­la­tion sets the retire­ment age for Medicare, or the eli­gi­bil­i­ty and ben­e­fit lev­els for Social Secu­ri­ty, for exam­ple. As peo­ple apply for and qual­i­fy for those pro­grams, their par­tic­i­pa­tion deter­mines the lev­el of spending.

Evi­dence shows that fis­cal mea­sures can have a sig­nif­i­cant impact both in rais­ing incomes and in reduc­ing unemployment.

So the dis­cre­tionary side — which includes things like edu­ca­tion and research that gen­er­al­ly pro­mote eco­nom­ic growth — has been squeezed much more than the manda­to­ry side. In fact we might think about expan­sions in this area to pro­mote growth and eco­nom­ic mobil­i­ty. But if you look at where the spend­ing growth comes from in the long run, it’s from the health and age-relat­ed pro­grams on the manda­to­ry side. And, the rev­enue side can also be made more effi­cient. I don’t think any­one is sat­is­fied with the cur­rent tax code.

KI: The ele­phant in the room being the fact that we as a nation are aging?

Eber­ly: Exact­ly. With no changes to Social Secu­ri­ty and Medicare, spend­ing goes up, because the num­ber of peo­ple who qual­i­fy for those pro­grams goes up over time, and so does the cost of health care.

KI: And what’s the sec­ond front for fis­cal action?

Eber­ly: There are always unex­pect­ed things hap­pen­ing in the econ­o­my. You want to make sure that you have some arrows in your quiver to be able to respond.

Right now mon­e­tary pol­i­cy — imple­ment­ed by the Fed­er­al Reserve — is still expan­sion­ary. Basi­cal­ly, the pol­i­cy inter­est rate is already as low as it can go. If fis­cal pol­i­cy — which is decid­ed by Con­gress and the exec­u­tive branch — were to pull back, and there was an unex­pect­ed shock to the econ­o­my (from Europe, say, or the Mid­dle East, or ener­gy prices) there is very lit­tle addi­tion­al room for mon­e­tary pol­i­cy to sup­port the economy. 

While fis­cal adjust­ment is need­ed to sta­bi­lize the debt-to-GDP ratio, the adjust­ments should not start while mon­e­tary pol­i­cy is still accom­moda­tive. You want the econ­o­my to gain suf­fi­cient strength for mon­e­tary pol­i­cy to pull back and renor­mal­ize. Then fis­cal pol­i­cy can pull back. That also leaves pol­i­cy mak­ers room to move in response to a shock to the glob­al econ­o­my. Even­tu­al­ly, we will want to rebuild fis­cal capac­i­ty, so that fis­cal pol­i­cy can also respond to future eco­nom­ic down­turns, just as we had to do dur­ing the finan­cial crisis.

KI: So what can pol­i­cy mak­ers do to build in more flex­i­bil­i­ty for deal­ing with eco­nom­ic shocks?

Eber­ly: Evi­dence shows that fis­cal mea­sures, such as those in the Amer­i­can Recov­ery and Rein­vest­ment Act (also known as the stim­u­lus pro­gram) can have a sig­nif­i­cant impact both in rais­ing incomes and in reduc­ing unem­ploy­ment. The les­son here is that fis­cal pol­i­cy can be pow­er­ful, espe­cial­ly in a severe down­turn where there’s under­uti­lized resources in the economy.

But in order to be able to use it when the econ­o­my is weak — in order to have the capac­i­ty to increase spend­ing and decrease tax­es and run a bud­get deficit — you have to know when to pull back. Peo­ple remem­ber the expan­sion when the econ­o­my is weak; they for­get about the adjust­ment when it is strong.

KI: That’s why you argue that pol­i­cy mak­ers should con­sid­er more auto­mat­ic stabilizers.

Eber­ly: Right. A big part of fis­cal pol­i­cy is auto­mat­ic sta­bi­liz­ers, which include things like unem­ploy­ment ben­e­fits, or Sup­ple­men­tal Nutri­tion and Assis­tance Pro­gram (SNAP) ben­e­fits. When the econ­o­my weak­ens and unem­ploy­ment ris­es, more peo­ple qual­i­fy. So spend­ing goes up in a reces­sion: a nat­u­ral­ly coun­ter­cycli­cal fis­cal measure.

Those things tend to stim­u­late the econ­o­my with­out any leg­is­la­tion being passed. They’re just auto­mat­i­cal­ly in place. They’re pre­dictable, they’re expect­ed and that also makes them more effec­tive because peo­ple know that, for exam­ple, if they become unem­ployed dur­ing a reces­sion, they can claim unem­ploy­ment ben­e­fits and that pro­vides them some insurance.

We pro­pose expand­ing the use of auto­mat­ic sta­bi­liz­ers both for eco­nom­ic rea­sons and also for prac­ti­cal rea­sons. For eco­nom­ic rea­sons, you’d like to see fis­cal pol­i­cy be coun­ter­cycli­cal so that fis­cal pol­i­cy comes in when the pri­vate econ­o­my is suf­fer­ing a down­turn and rolls off when the econ­o­my strength­ens. The prac­ti­cal val­ue is that it can be very hard to get poli­cies passed and imple­ment­ed in a time­ly way. And then, once pro­grams are in place, it can be hard to pull them back.

KI: Are you opti­mistic that we will make the changes we need to for improved fis­cal health over the next few years, or the next decade?

Eber­ly: We’ve seen move­ment already. We know that pol­i­cy is dif­fi­cult. There are many pres­sures, in addi­tion to good eco­nom­ic judg­ment, on the pol­i­cy process. I think there’s a lot of aware­ness of what needs to be done. The most opti­mistic path for­ward is for the econ­o­my to strength­en, and imme­di­ate pres­sures to abate, leav­ing space for longer-term deci­sion making.

But we need to pre­serve pro­grams – like ear­ly child­hood edu­ca­tion and research – that pro­mote growth. If there’s any sin­gle thing that will help the long run bud­get sit­u­a­tion, it’s strong growth. That goes a lot fur­ther than even the hard­est fought bud­get deals.

Featured Faculty

Janice C. Eberly

John L. and Helen D. Russell Professor of Finance and Faculty Director, Kellogg Public-Private Initiative

About the Writer

Jessica Love is a science writer and editor for Kellogg Insight.

About the Research

Eberly, Janice and Phillip Swagel. Fiscal Balancing Act. June 2014. (Prepared for the Peter G. Peterson Foundation.)

Read the original

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