Fiscal Balancing Act

Prepared by Janice Eberly (Northwestern University, NBER) and Phillip Swagel (University of Maryland) for the Peter G. Peterson Foundation

Key Findings from "Fiscal Balancing Act"

• America’s economic health is closely tied to its fiscal health. A strong and stable economy with sustained job creation and broadly-shared growth requires a foundation of fiscal responsibility. Likewise, a solid long-term fiscal foundation is supported by a growing, thriving economy. A well-targeted, balanced fiscal adjustment is thus not only a budget issue; it is an issue of long-term productivity and growth.

• Our long-term fiscal picture remains unsustainable. While the U.S. fiscal position has improved in recent years as we have emerged from the Great Recession, long-term sustainability has not been achieved, and economic growth remains below desired levels.

• Addressing the long-term fiscal imbalance can support economic growth and job creation. A gradual fiscal adjustment would provide a foundation for economic growth and stability, creating room in the budget for activities that promote broadly-shared income gains and mobility. Effective and well-targeted public investments contribute to prosperity by enhancing productivity and by creating an economic environment in which the private sector can thrive.

• Flexibility for future policymakers. Putting our long-term fiscal house in order during “good” times will give future policymakers more flexibility to use fiscal tools to support growth and job creation during the “bad” times. A stable and sustainable fiscal position, therefore, both ensures the ability to address future slowdowns and sets an economic foundation for long-run growth and prosperity.

• Fiscal adjustment should be gradual, fair, and protective of the most vulnerable. Fiscal policy changes should be implemented gradually as the economy improves and monetary support is correspondingly withdrawn. Because fiscal tools help to establish the safety net we value, fiscal adjustment should protect the most vulnerable and those least able to adjust to these changes.

Authors

• Janice Eberly is the James R. and Helen D. Russell Professor of Finance at the Kellogg School of Management at Northwestern University. From 2011 to 2013, Professor Eberly served as the Assistant Secretary for Economic Policy at the Treasury Department. In that capacity, she was the Chief Economist at the Treasury, leading the Office of Economic Policy in analysis of the U.S. and global economies and financial markets and development of policy recommendations on micro and macroeconomic issues.

• Phillip Swagel is a professor at the University of Maryland's School of Public Policy, where he teaches courses on international economic policy. He is also a senior fellow with the Milken Institute, and a visiting scholar at the American Enterprise Institute. Swagel was Assistant Secretary for Economic Policy at the Treasury Department from 2006 to 2009, responsible for analysis on a wide range of economic issues, including policies relating to the financial crisis and the Troubled Asset Relief Program.

Topline Highlights from "Fiscal Balancing Act"

• "A strong and stable economy with sustained job creation and broadly-shared growth ultimately requires a foundation of fiscal responsibility."

• "The U.S. fiscal position has improved in recent years, but long-term sustainability has not been assured, as budget deficits are still forecast to widen without future changes in government spending or taxes. A fiscal adjustment involving changes in revenues or expenditures is thus necessary…"

• "[A] fiscal adjustment should include creating room in the budget for activities that promote growth, mobility and stability. This set of priorities is grounded in good economic policy, since effective and well-targeted government programs contribute to prosperity by enhancing productivity and by creating an economic environment in which the private sector can thrive, while ensuring appropriate support for those most in need."

• "A gradual fiscal adjustment implemented in this way provides a foundation for economic growth and stability, creating an environment in which broadly-shared income gains and mobility are possible."

• "[Without a fiscal adjustment,] increased debt and expectation of normalized interest rates translates into increased costs of financing the federal debt, with net interest payments projected to rise from under 1.3 percent of GDP in 2013 and 2014 to above 3 percent of GDP by 2024."

• "Even if all else goes well, without changes to planned revenues or expenditures, the costs of programs that largely serve seniors will inexorably crowd out other areas of the federal budget. … Hence, the demands on the economy will be highest just as its capacity and its ability to generate fiscal resources is reduced."

• "[A] credible fiscal plan that ensures sustainability through gradual adjustment supports growth … [while] not ensuring fiscal sustainability ultimately would entail severe adverse economic consequences."

• "However, the distribution and accessibility of gains should not be taken for granted. Indeed, the adjustment should ensure both that fiscal sustainability is achieved in a gradual fashion and that resources are available for growth-enhancing public uses."

• "Faster growth generates more resources for both the private and public sectors; mobility implies greater accessibility to economic success and incentive to invest; and a more stable and resilient economy provides greater opportunity for all."

• "At some point, a sufficiently high level of debt would make it costly and difficult for the United States to undertake a debt-financed fiscal expansion in response to a business cycle slowdown. Truly countercyclical fiscal policy requires adjustment during the economic upswing."

• "Historical risks to sovereign borrowing include a high debt burden, rising interest rates, inability to collect taxes, weak governing institutions, and inability to control credit growth. The policy implication for the United States remains that actions are necessary to address the fiscal imbalance over time to avoid a market-based concern about the level of debt — the point at which the interest rate response would be salient."

• "The usefulness of fiscal policy over the business cycle goes along with the importance of fiscal sustainability in ensuring macroeconomic stability. A stable and sustainable fiscal position ensures both the ability to use expansionary policy when needed and the economic foundation on which to build a broad and accessible prosperity."

• "[F]airness dictates a modulated approach, since current seniors and those approaching retirement rely on benefits already promised for their later years. Protecting the most vulnerable and those least able to adapt should be a further guiding principle of fiscal adjustment..."

This report was prepared for the Peter G. Peterson Foundation. The statements made and the views expressed are solely those of the authors.