Only World Wars One and Two, and the American Civil War, caused larger deteriorations in the budget. Bank rescues, stimulus and tax cuts will bequeath a massive legacy of government debt, on course to reach a level not seen since 1947.
Stabilising government finances will require deep cuts in spending and sharp tax rises in the years ahead.
The need to refund the huge stock of maturing debt and issue new securities to cover deficits will also make it hard for the Federal Reserve to raise interest rates in a timely manner once the crisis has passed. Officials will face a protracted conflict between raising rates to head off inflation and keeping them low to stabilise the government debt market and contain government borrowing costs.
LESSONS FROM THE WAR
All the challenges now facing the Fed, Congress and President Barack Obama were prefigured by President Franklin Roosevelt in his annual budget message to Congress in January 1942, when the president outlined the enduring financial consequences of mobilising the government and the nation to fight a “total war”. Click here for pdf.